RBI quizzes banks on business models 

The Reserve Bank of India conducted an exercise to understand the business models of banks in its ongoing annual inspection, as the banking sector did not witness much disruption in the loan growth trends even with the increase in interest rates.

Every year, to make the routine annual examination of banks interesting, the Reserve Bank of India picks up a particular aspect and tests the banks. For fiscal ’23, the theme is sustainability of business models. We have learned from high-level sources that the banking regulator is closely understanding and asking banks about their business models in ongoing annual inspections. This is especially true for the ten largest banks in the country.

Despite the sharp rise in repo rates and lending rates, we haven’t seen much disruption to loan growth trends or asset quality at banks. This is unusual compared to previous rate hike cycles and the regulator is keen to see how banks manage such strong growth and profitability,” said the CEO of a private bank who did not wish to be named.

“Despite the declining base, most of the banks have seen rapid growth in their unsecured retail books specializing in MSMEs. This is something the RBI is not feeling and is gauging how long this trend can continue without hurting quality of bank assets.

Unsecured loans, a pain point

On April 30th Business line I mentioned that the Reserve Bank of India has asked banks to slow down on unsecured loans which have historically been 2-2.5 per cent loss-making business. However, in the current cycle, credit losses in this portfolio have been contained at a percentage or less for most banks.

“There are reasons to believe that much of the pain may be being masked by the faster growth in the sector, which leads the regulator to suspect that loan rollovers may be rampant,” said a person familiar with the matter.

Bank profitability reached an all-time high in FY23 and this is something the regulator did not expect. “Even if there were some signs of cooling off in revenue or net interest margin, that wouldn’t have raised red flags,” the source said.

Renew focus

In the past two years, the focus of the regulator has been to ensure that operations are fully scrutinized and do not suffer due to the pandemic. Now with these aspects not of concern to the sector, attention has shifted to the business models of banks.

“This year’s examination is focused on prospecting for the sustainability of growth published by banks without compromising credit standards and underwriting practices,” said another senior PSU Bank executive. Apparently, taking initial cues from the regulator, some banks have already begun to scale back their internal targets to ensure they are in line with regulatory expectations.