This might sound like perverse logic but the fact is, Indian bankers have never had it so good.
The unprecedented liquidity crunch that is forcing the Reserve Bank of India (RBI) to release money into the system any which way has dramatically changed the dynamics of the business of banking.
Till three months ago, about 80% of the borrowers were accessing money from banks at a rate below their prime lending rate (PLR), at which banks are supposed to lend to their prime customers. Today, only small farm loans and export credit are disbursed at less-than-prime rates (if the bankers are willing to give loans to them) and about 80% of the borrowers are raising money at much above PLR. Even prime borrowers are finding it difficult to get money at prime rates.
“We are making money with both hands. Till recently, the firms used to bargain hard to get cheap money. Now, we are dictating terms,” the chief of a large bank told me last week.
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His jubilation is understandable, but if all bankers get carried away by greed, they may end up digging their own grave as higher interest rates dent borrowers’ capability to repay loans. So, banks will accumulate stressed assets. On the other hand, if the bankers listen to finance minister P. Chidambaram and start giving money to every borrower and every business segment in trouble, they will mis-price the risk.
Except for two banks—Allahabad Bank and Kotak Mahindra Bank Ltd—most of the listed banks have announced handsome growth in their net profits in the July-September quarter. That’s good news. But the bad news is their non-performing or stressed assets have started growing and the deterioration in quality of assets will intensify with economic slowdown and rise in borrowing cost for consumers.
A loan turns non-performing when a borrower fails to pay the interest and principal for 90 days, and banks need to provide for such loans.
The gross non-performing assets (NPAs) of ICICI Bank Ltd, India’s largest private sector lender, rose from Rs9,501 crore in September, from Rs5,932 crore a year ago. For HDFC Bank Ltd, the second largest private bank, gross NPAs have at least doubled, although on a smaller base—from Rs768 crore to Rs1,676 crore.
Not too many banks, however, have shown much growth in their net NPAs because they have made hefty provisions to cover such assets. ICICI Bank’s net NPA in September went up to 1.91% of its loans, from 1.43% a year ago. For HDFC Bank, it was 0.60% against 0.40%, and for state-run Indian Overseas Bank, 1.44% against 0.35%.
By any yardstick, the NPA growth is not alarming yet but things can get worse as banks will not be able to make large provisions if their profitability comes under pressure. Besides, when credit growth slows, stressed assets as a percentage of loans will automatically go up.
Strains are already visible in certain sectors such as airline, real estate and non-banking finance companies. Small and medium businesses are also under considerable stress. They are asking for more working capital from banks not because they want to hoard money when liquidity is tight, but because their inventories are piling up. And, there will be trouble with home loan borrowers and credit card holders.
Some of the credit card holders in big cities who had never used their cards to draw cash are now doing that. Typically, the cash withdrawal limit is about 80% of the overall spend limit of a credit card. Consumers are using their credit card to generate cash and meet certain expenses and since most of the them hold more than one credit card with different billing cycles, they are drawing cash through one card and paying it off by using another and taking the credit forward with yet another.
This chain will continue for the next few months before they default on repayment. This will intensify as many professionals are seeing their take-home pay packets shrinking as the variable component of their salary is drastically coming down with the business downturn.
As a result, some are finding it difficult to meet financial commitments such as equated monthly instalments (EMIs) for auto, mortgages and other personal loans, and using their credit cards to pay. In certain segments such as brokerages, real estate firms and non-banking finance companies, retrenchments have started in a small way. This will intensify the pressure.
Banks’ mortgage portfolios, too, are under strain. With interest rates rising by one-third in past few months, in some cases, the EMI of a home loan is not even covering the interest payment. Typically, at the initial stage, EMIs cover mainly interest and a bit of principal and gradually the interest component goes down. Banks are restructuring EMIs as otherwise the length of home loans will become too long. With realty prices coming down sharply, even in case of a default, banks will not be able to recover their money by selling the flats.
So, they have a tough time ahead. If they increase the rates further (they can always do that despite a cut in their PLR), borrowers will be under severe stress and defaults will rise. And if money is sold cheap, beside hurting their profits, it won’t justify the risk they are taking by exposing themselves to borrowers who can go bust. Indian banks have not faced such a challenging time before.
Tamal Bandyopadhyay keeps a close eye on all things banking from his perch as the Mumbai bureau chief of Mint. Please email comments to firstname.lastname@example.org.