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Business News/ Industry / Banking/  Rules on foreign bank ownership meaningful only for three banks: Ismael Pili
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Rules on foreign bank ownership meaningful only for three banks: Ismael Pili

Macquarie Securities's Ismael Pili on why foreign banks seeking to buy Indian lenders may find few suitable targets

Ismael Pili says stressed assets of banks in India may touch a 14-year high of 13%, with the corporate debt restructuring cell seeing record references.Premium
Ismael Pili says stressed assets of banks in India may touch a 14-year high of 13%, with the corporate debt restructuring cell seeing record references.

Singapore: Foreign banks planning to buy Indian lenders may find few suitable targets even after central bank governor Raghuram Rajan eased rules allowing acquisitions of local banks that are outside state control, said Ismael Pili, head of financials research in Asia at Macquarie Securities. Smaller private sector banks in India are a lot like their state-run rivals with an aging workforce, poor operating metrics and strong trade unions, making them culturally unfit for an acquisition, he said.

Pili, who is underweight on Indian banks, compared with their Asian peers, said in an interview that stressed assets of banks in the South Asian nation may touch a 14-year high of 13%, with the corporate debt restructuring cell seeing record references as Asia’s third largest economy slowed to its weakest pace in a decade. Edited excerpts.

India recently changed rules to allow foreign banks such as HSBC Holdings Plc. to become wholly-owned subsidiaries. Do you think many global banks will take up this option and set up separately capitalized local subsidiaries? Do you agree with the Reserve Bank of India’s (RBI’s) view that the new rules are a significant step towards granting foreign banks equal treatment to domestic banks when they convert their local operations to subsidiaries?

The foreign bank issue is more meaningful for only three foreign banks—Standard Chartered, Citibank, and HSBC—as these three represent almost the entire foreign bank market. Currently, foreign banks in India operate through the branch route and, hence, conversion into subsidiary would attract stamp duty and other taxes, which are not under the purview of RBI.

Many foreign banks have frequently said in the past that ambiguity in tax laws discourages them to get converted into a subsidiary model. This may partly explain the reason for the cold responses. The biggest issue before had been the branch licensing regime, as expansion of branches for foreign banks had been very tightly regulated. Now that they’ve been brought on a par with other banks, foreign banks can expand more rapidly and be more competitive, assuming the foreign bank decides to go head to head with the domestic players. Increased competition usually leads to lower profitability for the incumbents.

Over the past week or so, shares of small-to-mid-sized private banks have been rallying. The reason that has been attributed to is that these banks are now acquisition targets for foreign banks. What is your view?

One problem is that the three large foreign banks operating in India need to comply with priority sector lending norms, which are very onerous and, hence, they may prefer the acquisition route. The problem is that many of these smaller private sector banks are old generation private sector banks, some as old as the PSUs (public sector units) in the country, with an aging workforce and poor operating metrics. They also have strong trade unions, and wage negotiations happen through the IBA (Indian Banks’ Association). Foreign banks may be ill-equipped to handle all these issues and, hence, gelling with the culture would be a huge deterrent. Moreover, these old private sector banks are community held, have a diversified shareholding pattern (no single large promoter), and quite often the communities which hold them are averse for a sell out. Note that smaller PSU banks are ruled out, as acquiring them requires legislative amendments and government support which is unlikely to happen.

What are your views on central bank governor Raghuram Rajan’s steps to shake up India’s banking establishment by proceeding quickly on the issuing permits to new banks?

The Indian banking sector needs to be shaken out of its doldrums or complacency (as some may say). However, there are things that he can’t do, such as those that need legislative action, such as the acquisition of smaller PSU banks.

On inflation and interest rates, there have been complaints in India that Rajan, while talking tough, is also raising interest rates. How do you think investors will view these steps such as the recent interest rate moves?

I thought he was looking to tackle inflation. In his first speech, he said that the primary role of the central bank is monetary stability, that is, to sustain confidence in the value of the country’s money. Ultimately, this means low and stable expectations of inflation, whether that inflation stems from domestic sources or from changes in the value of the country’s money.

Are you still underweight on Indian banks, compared with their Asian peers?

I’m still underweight on Indian banks, compared with their Asian peers. Our bearish stance on the sector revolves around its asset quality, liquidity, and capital standing. Asset quality is the biggest issue, given weaker currency, elevated interest rates, and a sharp collapse in demand that will keep slippages and restructured loans high. Stressed assets may touch a 14-year high of 13%, with the CDR (corporate debt restructuring) cell seeing record references, a lack of visibility on an economic recovery, and high credit costs due to higher stressed asset formation as well as regulatory driven charges, under a dynamic provisioning policy.

Most large assets restructured earlier may not be performing well, and there are still seven sizeable groups (equivalent to 3% of the system assets) that have yet to be restructured. The liquidity situation remains poor, with negative implications on loan growth, margins, asset quality, and treasury gains. Capital requirements for the PSUs could be huge. According to PMEAC (Prime Minister’s Economic Advisory Council), the base case equity capital raising estimate for PSU banks is closer to $42 billion with the government’s share being $26 billion over the next five years and the worst case estimate assuming 19% growth in RWA (risk-weighted asset) and higher NPLs (non-performing loans) is $51 billion with the government’s share being $31 billion. So the money that needs to be raised from the market would be $17 billion and $20 billion, respectively, which we believe is very large and doubt whether there is any market appetite for such large equity issuances.

Adjusting book values suggests PSU valuations are not cheap. We think the market still needs to pull down their EPS (earnings per share) assumptions behind a weak outlook on loan growth, credit costs, margins, and treasury gains. The good quality private banks are the only names that offer some appeal to us.

Why is that Asian economies, including that of India, are lagging behind the developed world rebound that we have been witnessing off late?

The lag is due to the slower growth outlook in this part of the region. Although economic growth in absolute terms is higher than the developed world, it’s the delta (change) that investors are looking at.

Where do you think emerging markets such as India stand currently? Some argue that the slump is cyclical, while others say it is due to structural problems. Do you think that the current slump is the new normal, or will it get worse?

The question on emerging markets is a hotly debated topic on whether it is, as you said, a temporary cyclical slowdown or a permanent structural issue. In my view, this cyclical headwinds will not sufficiently derail the structural appeal of emerging markets. Furthermore, the debate rages because many are either applying a broad brush to the entire emerging market class rather than isolate specific issues affecting individual countries. For example, how can one lump the Philippines with the issues affecting say, Indonesia or Malaysia or China. They’re unique in their own right. Developing markets, as the name suggests, continue to develop. Most still have a young growing population, with improving education, increasing productivity, and expanding infrastructure (albeit, perhaps not expanding fast enough).

There is also the view that emerging markets can use the current slump and grow without building up asset bubbles.

That is the positive aspect of a slowdown. It gives fast-running economies and markets a chance to take a breather, reassess and, hopefully, resume with a clearer outlook. Many Asian countries may have growing concerns on their debt level, but largely that’s on a personal and household level such as in Malaysia (where household debt to gross domestic product is pegged at around 83%). Corporate gearing remains very low—much, much lower than pre Asian financial crisis levels. I think many have learned their lessons from the Asian financial crisis.

What can emerging economies such as India do next to overhaul their economies? Should their focus be on infrastructure development or research?

Infrastructure is always the typical reply by most policymakers as the answer to the emerging markets’ plight. It’s nothing original, though probably correct. R&D (research and development) is the theoretical longer term objective behind the notion of higher value add, though I reckon infrastructure, education and health would get prioritized.

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Published: 15 Nov 2013, 12:22 AM IST
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