Mumbai: Public sector banks (PSBs) are pulling back on credit disbursement to lower rated companies, as they keep a closer watch on using their own scarce capital and the banking regulator heightens its scrutiny on loans being sanctioned.

Almost all large public sector banks that reported their first quarter results so far have showed a contraction in credit disbursal on a year-to-date basis, as most banks have shifted to a strategy of lending largely to government-owned “Navratna" companies and highly rated private sector companies.

On a sequential basis too, banks have grown their loan book at an anaemic rate.

To be sure, in the first quarter, loan demand is not quite robust. However, in the first quarter last year, banks had healthier loan growth on a sequential basis than this year.

The country’s largest lender State Bank of India grew its loan book at only 1.21% quarter-on-quarter. Meanwhile, Bank of Baroda and Punjab National Bank shrank their loan book by 1.97% and 0.66% respectively in the first quarter on a sequential basis.

Last year, State Bank of India had seen sequential loan growth of 3.37%, while Bank of Baroda had seen a smaller contraction of 0.22%. Punjab National Bank had seen a growth of 0.46% in loan book between the January-March and April-June quarters last year.

On a year-to-date basis, SBI’s credit growth fell more than 2%, Bank of Baroda’s credit growth contracted 4.71% and Bank of India’s credit growth shrank about 3%.

SBI chief Arundhati Bhattacharya said the bank’s year-to-date credit growth fell as the bank focused on ‘A’ rated customers. About 90% of the loans in the quarter was given to high-rated companies.

“Part of this was a conscious decision and part of it is because we actually did not get good fresh proposals in the quarter," Bhattacharya said.

According to bankers, while part of the credit contraction is due to the economic slowdown, capital constraints and reluctance to take on excessive risk has also played a role.

“Most of the PSU banks are facing pressure on capital adequacy. It is challenging to maintain 9% core capital adequacy. The pressure on monitoring capital adequacy and maintaining capital buffer is so strict that you cannot grow aggressively," said Rupa Rege Nitsure, chief economist at Bank of Baroda.

Nitsure said capital conservation pressures will substantially cut down “irrational expansion of loans" in some smaller banks, which used to grow at a rate much higher than the industry average. The companies coming to banks, in turn, will have to make themselves more creditworthy for banks to lend. “The conservation of capital is going to inculcate a lot of discipline in both banks and borrowers," she said.

For every loan that a bank disburses, some amount of money is required to be set aside as provision. Lower the credit rating of the company, riskier the loan is perceived to be. Thus, the bank is required to set aside more capital for a lower rated company than what it otherwise would do for a higher rated client.

New international accounting norms, known as Basel III norms, require banks to maintain higher capital and higher liquidity. They also require a bank to set aside “buffer" capital to meet contingencies. As per the norms, a bank’s total capital adequacy ratio should be 12% at any time, in which tier-I, or the core capital, should be at 9%.

Capital adequacy is calculated by dividing total capital by risk-weighted assets. If the loans have been given to lower rated companies, risk weight goes up and capital adequacy falls.

According to bankers, all loan decisions are now being assessed on the basis of the capital that needs to be set aside as provision against the loan and as a result, loans to lower rated companies are being avoided.

According to a senior banker with a public sector bank, the capital adequacy situation is so precarious in some banks that if the risk weight increases a few basis points, the proposal gets cancelled. The banker did not wish to be named.

One basis point is one hundredth of a percentage point.

Bankers add that the Reserve Bank of India has also started strictly monitoring how banks are utilising their capital. Any big-ticket loan to lower rated companies is being questioned.

In this scenario, banks are looking for safe bets, even if it means that profitability is being compromised.

“About 25% of our loans this quarter was given to Navratna companies, who pay at base rate. This resulted in contraction of our net interest margin (NIM)," said Bank of India chairperson V.R. Iyer, while discussing the bank’s first quarter results with the media.

Bank of India’s NIM, or the difference between yields on advances and cost of deposits, a key gauge of profitability, fell in the first quarter to 2.45% from 3.07% a year ago, as the bank focused on lending to highly rated customers.

Analysts, however, say the strategy being followed by banks is short-sighted.

“A high rated client will take loans at base rate and will not give any fee income to a bank. A bank will never be profitable that way. Besides, there are only so many PSU companies to chase. All banks cannot be chasing them all at a time. Fact is, the banks are badly hit by NPA and are afraid to lend now to big projects. They need capital, true, but they have become risk-averse," said a senior analyst with a local brokerage who did not wish to be named.

Various estimates suggest that Indian banks would require more than 2 trillion of additional capital to have this kind of capital adequacy ratio by 2019. The central government, which owns the majority share of these banks, has been cutting down on its commitment to recapitalize the banks. In 2013-14, the government infused 14,000 crore in its banks. However, in 2014-15, the government will infuse just 11,200 crore.

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