By any yardstick, the June quarter earnings of listed Indian banks have been spectacular, but let me play Cassandra and say the dream run will not last long.
The net profits of 41 listed banks in April-June have risen by 62% over the year-ago quarter, the highest in at least 12 quarters. As a group, public sector banks have performed better than their counterparts in the private sector by registering 70% growth in net profits against 41% of private banks.
One of the reasons behind this huge post-tax profit growth is lower provisions. Banks need to set aside a portion of their operating profits to provide for bad assets. In the June quarter, there was a 22.6% drop in provisions as banks’ bad loans have not grown much.
Data collated by Ashwin Ramarathinam of Mint research show that the main driver for profits is treasury income. The net interest income of all listed banks—interest earned on loans minus interest spent on deposits—has grown at a modest 13%, while the growth in the so-called other income, consisting of profits from trading in bonds and equities as well as fees and commissions, has been 62%. The public sector banks have done better than the private banks on both the parameters—net interest income as well as other income.
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Why will this dream run come to a halt and when? Banks will feel the heat in the last quarter of fiscal 2010. The immediate concern of the industry is low credit offtake. In the fiscal year so far, bank credit has grown by just about 2.6%, or Rs62,290 crore. Till 31 July, the year-on-year credit growth has been 15.8% (Rs3.83 trillion), against 25.6% (Rs4.95 trillion) a year ago.
A few months ago, a panel was set up to oversee the credit growth of the industry. Apart from a senior banker each from different regions of the country, a bureaucrat from the finance ministry and representatives of industry lobbies are members of the panel that meets at least once in three weeks. Even this committee has not been able to figure out why companies are not accessing bank loans.
One reason behind postponing their investment decisions could be a lack of belief in the early signs of economic recovery. Typically, in the beginning of the year, firms get the loans sanctioned by banks up to a limit, but they actually draw the fund as and when they require money. Banks don’t earn any interest unless funds are lifted by corporations. As the firms continue to shy away from lifting credit, banks have been planning to charge a commitment fee from them on money sanctioned but not disbursed.
Once corporations start accessing bank credit, banks will have a different problem; excess liquidity will be soaked and interest rates will rise. Banks are parking on an average about Rs1.3 trillion with the Reserve Bank of India (RBI), earning 3.25%. Besides, another Rs1.39 trillion has been invested in money market mutual funds, called liquid funds. These funds typically invest in short-term corporate deposits and government papers and offer a return of around 4.25% and banks can withdraw money at a very short notice.
The government plans to borrow Rs4.51 trillion from the market in fiscal 2010 to bridge its fiscal deficit, and the bulk of it is being raised in the first half of the year. Despite that, there is no pressure on interest rates yet as there is plenty of money in the system. Once interest rates rise, banks’ bond portfolios will be hit as they will be required to make provisions for depreciation in bond prices. When interest rates rise, prices of bond go down. Since banks are required to value their bond portfolio at the prevailing market price, and not the price at which bonds are bought, they will have to make good the depreciation.
When will the rates start rising? It could happen in the last quarter of the year. The wholesale price inflation that rose to a 16-year high of 12.91% in August 2008 declined 1.74% in the week to 1 August this year, but retail inflation continues to be high.
Consumer prices paid by farm workers jumped 11.52% in June from a year earlier and prices paid by rural workers rose 11.26%. The Indian central bank has raised the projected year-end inflation rate from 4% to 5% and it will tighten the monetary policy to fight inflation.
Yet another problem that the bankers will face is rise in bad loans. The level of bad loans has not been growing because RBI has allowed banks to restructure loans to help individual and corporate borrowers tide over the impact of the economic slowdown.
A recent study by ratings agency Care Ltd says the top 12 Indian banks have restructured loans worth Rs32,530 crore in the first quarter ending June, taking the amount of total restructured assets to Rs73,000 crore. Overall, about Rs1.1 trillion worth of loan assets are being recast. A loan becomes bad when a borrower fails to pay interest on it for 90 days.
For the restructured loans, borrowers are being excused from servicing such loans for six months to two years. Since the entire excise has been completed in June, those who are being given six months grace will have to start payment by the quarter ending December. Many of them, especially the exporters, are likely to default again.
If that happens, banks will have no choice but to classify these accounts as bad assets and provide for them. This will pull down bank profits.
Tamal Bandyopadhyay keeps a close eye on all things banking from his perch as Mint’s deputy managing editor in Mumbai. Comment at firstname.lastname@example.org