Impact of COVID-19 on Indian Banks in the Near-Term

The COVID crisis has resulted in an unprecedented disruption to the economic activity, and will lead to major changes in operations of most industries, including banks. Given below are some views on how banks will need to adjust to the new reality once situation stabilises and economic activity starts resuming normal operations. While this note has been made keeping India in mind, most conclusions will be valid for other emerging economies as well.

There are certain industries which will take longer to rebound – so banking exposures to these industries need to be carefully monitored – examples would be travel, tourism, hotels, airlines. There are other industries which will be affected less and would rebound faster, like pharmaceuticals, e-commerce, FMCG.

Products: due to disruption in supply chains, most businesses are likely to see a much longer working capital cycle. As the economy is coming out of the crisis, there will be sufficient production capacity, but the availability of working capital could act as the lubricating oil or an impediment in that process. In the medium-term, businesses are likely to keep a higher buffer of current assets like raw material and inventories. In general, businesses will keep more of their assets in liquid funds, even if that means some sacrifice in terms of return on assets. For all these reasons, banks are likely to see significant increase in demand for their working capital financing, cash management, trade finance and transaction banking products.

Larger corporates will like to keep committed but undrawn credit lines from banks – to that extent, banks’ ALM will need to become more dynamic.

Since the focus in the short-term will be on stabilisation of existing operations and conservation of liquidity, there may not be much demand for term loans for capital expenditure. However, term loans for refinancing and for core working capital requirement will continue to be in demand.

Small and Medium Enterprises are the backbone of Indian economy, and they are bearing the brunt of the current situation, on all fronts – raw materials, supply chain, customers, employees, working capital. The Banks’ divisions which deal with SME clients, will see a big spurt in demand for funds and other banking services, as these SMEs try to bring their businesses back towards normalcy.

There will likely be a pent-up demand for auto loans and other personal loans, which the banks will need to meet as the situation normalises. Demand for commercial vehicles will increase only in the medium-term once the economic activity reaches the pre-Covid levels. Housing finance will remain subdued, since individuals would postpone purchase of real estate for some time. Due to fall in interest rates across the economy, there would be demand by borrowers (both individuals and businesses) to refinance their older, high-cost loans.

There will be many firms who will not be able to survive this crisis and will default on their obligations, and may even go bankrupt. This will be especially true for firms in industries which would be significantly impacted (few mentioned above) as also those which were highly leveraged. Hence the restructuring and stressed assets divisions of the banks will have their hands full for a few years.

Deposits: post-Yes Bank episode, Indian banking system has been seeing a flight-to-quality of deposits, whereby depositors are shifting funds out of smaller banks. This has been beneficial to all large banks – both government and private. This trend will continue.

Indian government and RBI will be pumping in substantial liquidity into the system, to enable availability of requisite credit to corporates and individuals. This will lead to a fall in interest rates, and the trend has already commenced. Such fall in interest rates will have a significant impact on banks’ ALM, treasury activities, and most parts of the banking business. Globally, governments in USA and all large economies are on a similar path, so liquidity is unlikely to be a concern for quite some time.

Banks have been trying to push their retail customers towards online banking and other digital channels as much as possible, and rely less on branches. Covid crisis will give a push to these efforts – we may see a trend towards bank branches being downsized to smaller setups with fewer employees. Government banks will need to make their digital offerings more customer-friendly, and bring them in line with the private sector banks.