Thread by @zerodhamarkets

The Reserve Bank of India's recent 'Trend and Progress of Banking in India 2023-24' report gives crucial insights into the health of our financial system. Why does this matter? Banks are the heart where money flows in and out, fueling businesses and dreams alike. When banks thrive, the economy follows suit. But when they falter, the ripple effects are hard to ignore. 🧵👇

So, what’s happening with Indian banks? The first thing to know is that deposits and loans—or advances, as bankers call them—are two of the most critical numbers to watch in banking. Deposits are essentially the money people and businesses park in banks, while advances are the loans banks give out. Both are lifelines for the economy.

In the financial year 2023-24, deposits grew by 13.4%, while advances expanded by a whopping 16%. A faster lending rate than collection indicates a credit-hungry economy. However, a narrow gap between credit growth and deposit growth points towards stiff competition for funds.

Interestingly, while deposits still form a significant chunk of a bank's liabilities, their share has slightly declined. Borrowings, on the other hand, have picked up, increasing from 8% to 9% of liabilities.

Why? It’s partly because banks are chasing higher profits. Lending money earns them more than parking funds in government securities, which are safe but offer lower returns. Loans and advances now make up 61% of total bank assets, while investments in government bonds have fallen to 26%. This is a calculated risk—more loans mean more income, but it also increases vulnerability to bad loans if borrowers default.

Indian banks are not just surviving—they’re thriving. For six straight years, their profitability has grown. In 2023-24, two key measures of efficiency—Return on Assets (RoA) and Return on Equity (RoE)—improved to 1.4% and 14.6%, respectively. These may sound like small numbers, but in the banking world, they reflect significant gains.

At the same time, banks faced rising costs. The cost of funds—the average interest banks pay to gather money from depositors and lenders—jumped by 104 basis points to 5.1%. Private banks felt this pinch more acutely, with their costs rising to 5.4%, compared to 5.0% for public sector banks. Small finance banks, which operate in niche markets, saw the highest costs at 7%.

Despite the higher costs, private banks had a substantial lead in profitability. Their spread—the difference between earning on loans and pay on deposits—stood at 4.1%, higher than the 2.9% spread of public banks.

To address the credit-deposit gap, banks offered higher rates on term deposits. By March 2024, private banks' average rate for new term deposits reached 6.6%, up from 4.5% two years earlier. This led to a 42.9% rise in interest expenses, which grew faster than the 29.9% increase in interest income.

Even with these challenges, profits surged. Overall, net profits jumped 32.8% to ₹349,603 crore. Private banks led the way with a 41.2% increase, while public sector banks saw a 34.9% rise, thanks to better efficiency and improved asset quality.

This year saw a significant achievement for Indian banks: a sharp decrease in bad loans. Gross Non-Performing Assets (NPAs)—loans that borrowers fail to repay—plummeted to 2.7%, the lowest in 13 years. Net NPAs, which account for provisions already set aside for bad loans, hit a decade-low of 0.62%.

This remarkable drop in NPAs was fostered by a serious bank push for debt recovery. Banks employed various strategies:

- The SARFAESI Act allows banks to seize and sell assets that borrowers pledged as collateral. This method is quick and effective for smaller loans backed by assets like property.

- The Insolvency and Bankruptcy Code (IBC) focuses on large and complex cases. Companies in financial trouble are restructured or liquidated through legal tribunals. While this process can be slow, it has been instrumental in recovering nearly 28.3% of the total amounts involved in insolvency cases.

- Sales to Asset Reconstruction Companies (ARCs) allow banks to sell bad loans to specialized firms that attempt to recover the money. Although this method accounted for only 5.8% of recoveries this year, it remains an important tool for clearing bad loans off the books.

Together, these mechanisms have helped banks clean up their balance sheets, freeing up resources for fresh lending.

Banks’ lending patterns also reveal a lot about the economy. Retail loans—personal loans, home loans, and vehicle financing—saw robust growth, reflecting strong consumer demand. Credit to Micro, Small, and Medium Enterprises (MSMEs) also grew significantly, aided by government schemes like the Emergency Credit Line Guarantee Scheme (ECLGS).

However, not all sectors are doing equally well. Agriculture loans grew modestly, but the sector continues to struggle with high NPAs—8.5% of total loans to agriculture remain unpaid. Infrastructure and power sectors, while stable, are still grappling with legacy issues, including high levels of bad loans.

This paints a mixed picture: credit is flowing freely into high-growth areas like retail and MSMEs, but old challenges in sectors like agriculture and infrastructure persist.

The Indian banking system is stronger today than it has been in years. Profits are rising, bad loans are falling, and efficiency metrics are improving. But the risks can’t be ignored. Banks are taking on more borrowings, which could squeeze their margins. They’re also betting heavily on lending, which makes them more vulnerable to defaults if the economy slows down.

It’s a delicate balancing act. On one hand, the banking sector’s performance shows a healthy appetite for growth. On the other, it’s a reminder that growth always comes with risks. Banks are walking a tightrope, and their success or failure will have far-reaching consequences for the economy as a whole.

As we watch these trends unfold, one thing is clear: the story of Indian banks is not just about numbers. It’s a story of how money moves, how risks are managed, and how the economy evolves. And in that story, every deposit and every loan tells a tale of its own.

We cover this and one more interesting story in today's Daily Brief. You can watch the episode on YouTube, read on Substack, or listen on Spotify, Apple Podcasts, or wherever you get your podcasts. All links here: thedailybrief.zerodha.com/p/the-surprisi…