Indian banks risk Rs 12 trillion Covid-19 hit, says McKinsey

05 January 2021 Consultancy.in

Although resilient in the face of Covid-19, banks in India will have to withstand trillions in credit and revenue losses for this year, and a few more to come. This is according to new analysis by McKinsey & Company. 

Foregone revenues in India could exceed Rs.5 trillion by 2024, while credit losses could approach the Rs.7 trillion mark. The dire country-specific numbers come against the backdrop of a global banking industry in turmoil – marked by nearly $4 trillion in revenue losses and trillions more in credit write-offs.

“Our research finds that in the months and years to come, the pandemic will present a two-stage problem for banks. First will come severe credit losses, likely through late 2021. Then, amid a muted global recovery, banks will face a profound challenge to ongoing operations that may persist beyond 2024,” noted McKinsey & Company India Senior Partner & Head of Financial Services Akash Lal. 

The road ahead for banks

Credit crunch

Banks had already provisioned for loan losses of $1 trillion by the third quarter of this year – higher than the entire sum for 2019. And this is will only persist with time. By 2024, McKinsey expects credit loss provisions to far exceed the levels reached during the global financial crisis of 2008.

In India, loan defaults were already reaching unsustainable levels before this year, sparking cries for widespread banking reform. Covid-19 has only served to worsen this scenario. Many factors are at play here, although the central issue is the income squeeze amid a global economic crisis.

Loan loss provisions – history and forecast

A vicious cycle has emerged, where cash-squeezed businesses are making heavy-handed cuts to jobs and salaries, causing consumers to spend less. And dampened consumer spending only spells detriment for businesses. Amid all this, few have the financial room to make loan payments. In time – particularly as the vaccine rolls out – all the government support measures currently in place are expected to dry up, leaving businesses to fend for themselves. For banks, this means a squeeze on credit earnings for the next half a decade at least.

Revenue squeeze

According to McKinsey, 20% of revenue losses for Indian banks can be pegged on volume compression – suppressed loan activity as income dips discourage borrowing. Add to this the fact that most consumers are funnelling their income into savings rather than investment accounts – narrowing the earnings column for banks.

Banking revenue losses forecast

Then there is the issue of interest rates, which have been at near zero for almost the whole year. The resultant margin squeeze is wiping out 10% of revenues for Indian banks. As it stands, the firm reports that Indian banks will have to clock productivity improvements of up to 30% if they want to resume pre-pandemic levels.

The way forward

The good news is that this is still a possibility for most. While devastating, Covid-19 is unlikely to be fatal for the majority of banks, for a variety of reasons. One is that banks went into this year with healthy capital reserves – built up with the precise intention of surviving the next crisis.

The second factor is that Covid-19 has been a crisis of the economy, and not of banks. With healthy fundamentals within themselves, banks face the task of weathering the storm and waiting for things to normalise – a challenging prospect but not an insurmountable one. What is required is a change of approach.

McKinsey points out that banks in India and around the world are so far focused on cutting costs to survive the crisis. Instead, they would be well served to make strategic investments in infrastructure – particularly in the digital space. If anything has thrived during Covid-19, it has been the online world.

Everything – from business to shopping – has been handled virtually this year, and banks that are well equipped to serve this demand will win out from the crisis. In India, banks are lagging behind when it comes to digital infrastructure, spelling an imperative tech investment agenda in the next few years.