Resilient Banks Face Cost Challenges Beyond Technology
Banks are the cornerstone of the financial sector at the national as well as global level. To maintain stability, banks need to maintain liquidity and stable profit margins. Currently Indian banks are facing the issue of profitability margins and operational costs. In 2025, Indian banks are expecting the Reserve Bank of India to issue final guidelines on the number of subjects related to compliance. For this, the draft has already been circulated by the RBI. The subjects taken into consideration range from higher provisioning on project finance, higher run-off rates for liquidity coverage ratio (LCR), climate-related financial risks, and focus on credit management models. The critical issue banks face is credit risk due to Non-Performing Assets (NPAs). The RBI is also going to address this issue and also other risks that banks often faced affecting their books. The Central Bank also focuses on issuing guidelines related to restricting banks and their subsidiaries from performing overlapping businesses.
RBI focusing on these different subjects related to Banking function indicates that the year 2025 would be a challenging year for Indian Banks. It will lead to a rise in compliances and its cost. Also compression in margins due to stagnant deposit growth, competition for fee business and issue of operational cost. Despite progress in technology in the banking sector, it is difficult to lower operating costs. Resulting overall pressure on profit margins. Aso if the economic growth remains stagnant, it will affect other incomes of banks such as guarantees and commissions.
According to banking analysts, the banks have good capital structure and the NPAs’ share is at decadal low. Also they hope that the banking and financial institutions will not face any kind of severe shocks in this year. Despite this postive situation, the increasing number of Cyber frauds will keep the banks in constant tension.
The Indian banks are already facing the issue of less net interest margins (NIM). The NIM is the difference between the interest payment on deposits (cost of funds) and interest charged to borrowers. NIM also acts as a key indicator of a bank’s earnings. Last year, the NIM was narrowed down by 50 bps. According to RBI’s latest Trend and Progress of Banking Report, banks’ earnings based on NIM as key indicator was at 3.5 percent at the end of September 2024 as compared to 4.1 percent in the previous year for all the commercial banks. The guidelines of RBI that will be implemented in 2025 will likely lead to an increase in regulated banking structure as it will aim at making banks financially strong and more accountable and transparent. Despite this, it will certainly affect the performance of the banks. As the pressure on profitability margins is increasing due to rising credit cost and capital requirements in high-yield sectors such as unsecured loans. It could lead to banks to shift to more secured retail and corporate lending. The capital requirements are high in unsecured loans due to lack of collateral, higher risk of defaults, and has to follow regulatory requirements stated by RBI.
Increased use of technology in banking functions such as implementation of KYC norms, block chains for smooth transactions and use of technology for giving other customer services is observed in the banking sector. The aim of using technology was not only to make the banking process hassle-free for customers but also to lower the operational costs banks faced while performing banking activities. Despite the increased use of technology, the banks are expected to face high operational costs due to technology failing to replace humans as resources. Reason for this is that advanced technologies are complex and expensive in nature. It requires not only to invest in infrastructure but also to employ skilled professionals to manage these technologies. Also implementation of technologies need extensive training of the employees which comes with a cost. The functions like deciding the creditworthiness of the borrowers and amount of loan and interest rate to be given cannot be solely decided on the basis of data analyzed. It needs human perspective and strategies. Also many customers still prefer human interactions in terms of grievances and help while going through banking services and its products.
According to the report of RBI, the banks’ operating expenses have increased by Rs. 5.9 lakh crore in the fiscal year 2024 which is 20 percent more compared to the previous year. Also strengthening of regulatory compliance will lead to increase in cost of non-compliance. This will lead to an increase in reputational and business loss more than the past.
Apart from this, banks have to focus on their lending channels. In sectors, it faces a slow down. While in some industries such as chemical and chemical products, infrastructure, petroleum, coal products and nuclear fuels faced increased growth. Overall increase in loans to industry rose by 8.1 percent Y-o-Y in November 2024 compared to the previous year of growth of only 5.5 percent. Also, the retail sector recorded growth of 16.3 percent compared to 18.7 percent in the previous year due to a decline in growth in unsecured loans, vehicle loans and credit card outstanding. According to the RBI, housing loans, which has the largest share in retail lending, observed accelerated growth. Indicating that technology alone cannot resolve all the concerns of the banks.
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