Mumbai: It’s a double whammy for public sector banks.
State-owned banks, which make up about 70% of the Indian banking industry’s assets, will not only have to wait until July 2011 for full reimbursement of farm loans they have waived this year, but also need to immediately set aside about Rs3,600 crore in provisions to cover such loans.
The banking regulator, the Reserve Bank of India, or RBI, doesn’t want the lenders to treat the loans as “performing” assets unless the provisions are made on their balance sheets.
In banking terminology, performing or standard assets are loans on which borrowers do not default. When they start defaulting, an asset becomes categorized first as substandard, then doubtful, and finally a loss for which a bank needs to make 100% provisioning.
Public sector banks have started lobbying with the Indian central bank as well as the finance ministry for a waiver of the provisioning requirement, which could wipe out a substantial portion of their June quarter profit.
The collective net profit of public sector banks in the April-June quarter was around Rs5,350 crore, with State Bank of India posting the highest, Rs1,640.79 crore, followed by Bank of India (Rs561.95 crore) and Punjab National Bank (Rs512.4 crore).
See: Taking a hit
“If RBI sticks to its guidelines on the accounting norms for farm loans that have been waived, our profitability will be seriously hit,” said the chairman of a large public sector bank who did not want to be identified.
A finance ministry official, however, downplayed the development, saying: “It’s not a very big amount.” This official also spoke on the condition of anonymity.
Under a directive by the Union government, lenders waived Rs71,700 crore of farm loans this year, of which public sector banks’ share was Rs30,640 crore.
While small farmers, cultivating more than 1ha and up to 2ha of agricultural land, and marginal farmers, cultivating up to 1ha, received a full waiver, other farmers had 25% of their loans written off under the plan, provided they are ready to clear the rest of their debt in three instalments in one year. Overall, 43 million farmers benefited.
The banks have already waived the loans, but the government has not paid them yet. Still, banks are not complaining because they have no liquidity problems. With credit growing at 21% year-on-year, public sector banks are in a position to continue financing loans to farmers, consumers and companies.
RBI wants banks to provide for the “loss” in the net present value of these loans because they will be paid by the government over a period of more than three years.
Net present value is the difference between the present value of cash inflows and outflows.
The central bank has assumed that 32% of the due amount will be received by September 2008, 19% by July 2009, 39% by July 2010 and the remaining 10% by 2011. The regulator has also said that the discount rate for arriving at the present value of these cash flows should be 9.56%, which was the yield to maturity of the 364-day government of India treasury bill prevailing on the date of the RBI circular—30 July.
Applying this discount rate, a Mint analysis shows that the present value of the four instalments is Rs27,049 crore. Since the banks have waived Rs30,640 crore worth of loans, the difference—Rs3,591 crore —is the loss in present value terms and will have to be provided for in banks’ profit and loss statements.
Banks’ balance sheets will also be hit on another account. Most of them wrote back in the June quarter provisions already made on stressed farm loans in the belief they will be paid by the government. But, RBI norms do not allow them to do so, requiring them to reverse these entries.
For instance, a large public sector bank had written back some Rs85 crore worth of provisions made earlier in its June quarter earnings and this money propped up its net profit. Now, it will have to reverse the entry.
This bank is not alone. Most public sector banks followed this route to show higher profits in the three months to June as they were assured of government reimbursement of all farm loans that were waived.
The twin blows will substantially weaken the profitability of public sector banks, which are demanding a higher subsidy from the government to be able to offer farm loans at 7%, now a full 2 percentage points less than the policy rate in India.
Under banking rules, at least 18% of loans must go to agriculture. This is within the overall limit of “priority sector” lending norms that require all Indian banks to direct 40% of their loans to sectors such as the small-scale industry, small business and exports, besides agriculture.
Public sector banks have been doubling their exposure to agriculture every year and lending to small farmers at 7%, with the government chipping in 2% to offset the cost of funds.