The Banking Sector Reveals the Middle Classes Aren’t Really Getting a ‘Bonanza’

There is a euphoria around the “tax bonanza” offered to the middle classes in this year’s Budget. The proposal of no tax for those with annual income up to Rs 12 lakh has been hailed by the media, with many even calling this a “middle-class budget”. Of course, there are serious concerns as to whether the economy, in the pickle that it is, can be revived only with this relief for a tiny fraction of the middle classes, given that less than 2% of Indians seem to pay direct taxes. But that aside, what one finds amusing is the manner in which the middle classes respond to such moves. While a one-time deal like this creates cheer, egged on of course by the media, there is hardly any reaction to the holes burnt into middle-class pockets over time. Let’s look closely at the banking sector.

Middle classes form the bulk of depositors in the banks. It is these deposits that in turn form the bulk of the working capital that allows banks to operate. This year’s Economic Survey, in fact, rejoices in the double-digit growth in bank deposits. And yet, middle-class depositors have been shortchanged over the years by the dwindling interest rates on their savings bank deposits. “The interest on savings bank accounts, which was 5% in 1977, was brought down to 3.5% in 2003, and now it has come down to 2-2.5%,” says Thomas Franco, former general secretary of the All India Bank Officers Confederation. “If the middle classes were paid their fair share of interest at say 5%, they would have earned near about Rs 1.8 lakh crore more last year.”

This is far more than the Rs 1 lakh crore that the finance minister claims to have “foregone” with the tax rebate she bragged about. Fixed deposits account for nearly 60% of all bank deposits, and as per the Economic Survey, its share in bank deposits is growing. If one takes into account that the interest rates on FDs have nearly halved over the last two decades, the actual earnings foregone by the middle classes are massive. And yet, there seems to be a general acceptance of this as fait accompli.

Also read: Why the Union Budget 25-26 Doesn’t Spark Joy (or Growth and Consumption)

The real story behind disappearing NPAs

The Economic Survey released the day before the Budget, while evaluating the government’s performance in the banking sector, applauds the “consistent improvement” in the profitability of banks. It celebrates the fall in the Gross Non Performing Assets (GNPAs) to a “12-year low”. What the Economic Survey doesn’t not mention, however, is the scale of the massive write-offs being orchestrated backstage. The banks have written off a whopping Rs 16.5 lakh crore in bad loans over the last decade. In fact, Rs 1.69 lakh crore has been written off in 2024 alone! It is the public sector banks (PSBs) that have taken the major share of these write-offs and it is the corporates who account for the major share of these bad loans or NPAs. A deep dive into the Trend & Progress of Banking report and the Financial Stability Report released by the RBI at the end of 2024 give us a glimpse of the many tricks up the government’s sleeves.

One such trick to make these bad loans disappear is the creation of Asset Reconstruction Companies (ARCs), made so that banks could sell their bad debts and clean up the banks’ balance sheets. During 2023-24, out of the total bad loans (or GNPA), the share of bad loans sold to ARCs declined to 5.8% from 9.7% in the previous year. However, the share of PSBs and foreign banks has increased. In 2023-24, PSBs and foreign banks sold bad loans at significant discounts. The actual value of these loans remained much higher (orange bars in Figure 1.b) than the price paid by the ARCs to buy them (yellow bars).

Figure 1: Bad loans to ARCs

Now let’s look at the magic salons or the Insolvency and Bankruptcy Code (IBC). Despite being created to help banks recover assets from the insolvent companies, the actual results remain disappointing. The overall NPA recovery rate through different channels still hovers around 16% in 2023-24. When it comes to the IBC, while the number of cases referred to it rose from 704 in 2017-18 to 1,004 in 2023-24, the recovery rate plummeted from 50% to a mere 28.3%. And by the Economic Survey’s own admission, the haircuts in these magic salons still remain as high as 69%. So, for every Rs 100, the banks are bearing a loss of Rs 69!

Banks have to make arrangements to adjust these losses. They set aside money from their profits to cover for these potential losses from loans that may not be repaid (i.e. NPAs), for taxes on their profits, for risky investments, etc. This is called provisioning. According to the Financial Stability Report, by September 2024, banks were setting aside Rs 77 for every Rs 100 of expected losses. The orange bulge over the last decade in Figure 2 shows the sheer weight of provisioning just to cover for bad loans or the NPAs. Even now, out of the Rs 89,555 crore reserved for bad loans by the banks, the majority – Rs 60,714 crore – comes from PSBs which have a higher share of provisions for bad loans than private banks (see the green bars in Figure 3).

Figure 2: Year-wise provisions made by banks

Figure 3: Bank group wise provisions. Source: RBI, Stastical Tables Relating to Banks of India

Who bears the cost?

Now, many claim that these write-offs and provisions are simply an accounting exercise by the banks with no real consequence. But there are no free lunches, ever. The price for the NPAs of the big corporates is ultimately paid by the aam aadmi. Given that such huge provisions for the NPAs tie up a large portion of funds, it in effect limits the credit available for lending to key sectors like agriculture or MSMEs. Zico Dasgupta in his piece in the State of Finance in India report in fact demonstrates how the PSBs “could meet a lower proportion of the credit requirement of the MSMEs during the period of burgeoning NPAs”. The same would be the fate of marginal borrowers like farmers who struggle to secure necessary credit.

If one looks at the dipping red line in Figure 4, one can clearly see the repercussions in the form of the declining share of priority sector lending by the public sector banks, which has dropped from 33.8% in 2020-21 to 30.2% in 2023-24.

Figure 4: Priority sector lending. Source: RBI, Statistical Tables Relating to Banks of India

Adding to this disparity is the increasing reliance on Priority Sector Lending Certificates (PSLCs). These are certificates that the banks buy to just meet lending targets rather than directly giving credits to the priority sectors. The total trading volume of PSLCs grew by 25.5% in 2023-24, with Small and Marginal Farmers (PSLC-SMF) witnessing the highest demand (see the green bars in Figure 5), driving up its weighted average premium (i.e., the average price paid by banks to buy these certificates). This shows that the banks are merely complying with targets, instead of lending directly to small and marginal farmers.

Figure 5: Trading volume of PSLCs

Changing priorities

If one needs more clarity on the new priority of the banks these days, one just needs to look at the interest rates for loans. Over the years, the cost of borrowing (interest rates) for businesses like infrastructure, trade, industry and professional services has gone down significantly. If companies in these sectors had to pay 13% interest on loans in 2014, they now pay around 8-9%. However, for farmers, the interest rate on loans has stayed nearly the same at around 10%. They don’t seem to have benefited from lower borrowing costs like other industries have.

What the Economic Surveys will not tell us is that instead of serving as an instrument of redistribution of resources through credit support to the marginalised, the banks have been turned into a tool to precipitate inequality. They are designed now to draw from the bottom and aggrandise the coffers of those at the top.