There is a lot of uncertainty regarding the quantum of obligation that banks will add to their outstanding retirement liability along with the extent of provisioning for the same due to the second pension option (SPO) and increased gratuity limits. According to our analysis, pension liability (pre-tax) for state-owned banks will catapult by Rs 33,000 crore.
This translates into a hit of 14% on net worth and, if allowed to be amortized over five years, will imply a hit of 17% on earnings for banks. However, our downward revision in earnings estimate is pegged at 3-7% as the Street has factored in some provision based on pension liability indicated by banks.
We believe state-owned banks’ cost structure will undergo a structural change with almost the entire workforce falling under the pension scheme. The servicing costs of pension is about 24% of basic pay, implying a 3-4% rise in employee costs. We expect cost/income ratio for banks to move up by 100-150 basis points (bps) and return on equity to be adversely impacted by 40-60 bps as cost escalation is structural in nature. Moreover, banks will be exposed to shortfall/surplus on account of actuarial valuation for the entire workforce.
We arrive at the bank’s SPO liability (pre-tax) at about Rs 27,000 crore implying that extrapolating Union Bank of India’s liability only to arrive at SPO obligation for other banks will lead to an overestimation. However, what is not much discussed is the jump in banks’ liability due to increase in pension obligation for employees already under the scheme due to the wage revision—we estimate catch up liability at Rs 5,900 crore.
Dearness allowance (DA) is another pressure point in banks’ employee cost, given the high inflation scenario banks are operating in. DA adversely impacts employee costs due to a higher wage bill, pension payout and rise in provisioning for retirement benefits. Sensitivity of retirement liability to DA is maximum compared with other variables such as life expectancy.
The moot question at this stage is what caused the quantum jump in SPO liability to such high levels from Rs 6,300 crore estimated at the time of settlement. While Rs 6,300 crore was based on 2007 salary levels, that is before the wage hike, our numbers incorporate the current service costs for each year of service in between, wage hike impact and the DA increase.
Effective 24 May, the Gratuity Act, 1972, was amended, increasing the ceiling on gratuity payable from Rs 3.5 lakh to Rs 10 lakh. While the impact of increased limits on gratuity provisioning is difficult to calculate given different bank specific policies, we have estimated incremental gratuity liability due to wage hike and pegged the increase at 16% of outstanding gratuity obligation. We estimate incremental provisioning on this count at Rs 1,500 crore for the industry.
There is a lot of uncertainty regarding the quantum of obligation that the banking industry (state-owned banks excluding State Bank of India, or SBI, but including SBI associates) will add to its outstanding retirement liability along with the extent of provisioning for the same due to SPO and increased gratuity limits.
Edited excerpts from a report by Edelweiss. Your comments are welcome at email@example.com