Analysis. Banks search for revival in 2017

Demonetisation may have temporarily shifted the spotlight away from the problems of banks, but early 2017 will herald in their yearly performance.

During the current half year, the 28 public sector banks (which account for over 80 per cent of the system) posted an overall loss of around ₹900 crore; this may seem an improvement from last fiscal’s losses of ₹18,000 crore, but when we consider that the reduction was due to treasury and trading gains of a handful of banks, the message is clear — lending is becoming unprofitable and the villain is the mounting NPA stockpile.

Gross NPAs of the system have climbed relentlessly from ₹4.7 lakh crore last fiscal to over ₹6.5 lakh crore in September 2016. Particularly concerning is the fact that the accretions are mainly from slippages (from restructured standard assets) than from fresh credit, indicating the failure of restructuring. The asset quality review was essentially an accounting exercise to get banks to recognise and provide for asset value depletion and was, in a sense, the easier part of the resolution process, but the real problem will be unlocking cash flows from the NPAs — through sale, settlement or recovery. Consider this — at a weighted average lending rate of 10 per cent, the foregone interest income alone is over ₹65,000 lakh crore annually, not to mention the principal repayments. Unless assets are sold off or recovered, this massive cash deficit will require increased borrowings or higher deposits accretion. Deposit growth has also been slowing to around 6 per cent in FY2016. This will be the primary challenge for banks next year and it remains to be seen how the new tools like the Bankruptcy and Insolvency code will help. There is still a large stock of restructured standard assets with banks and the RBI’s own estimation of the systemic GNPA to advances ratio at over 9 per cent by March 2017 seems on target.

If unlocking resources from bad debts will be a huge task, an equally difficult challenge will be that of profitability. We need to remember that, unlike private or foreign banks, public sector banks largely rely on lending income to grow their profits. Unfortunately, credit growth has been abysmal at around 6 per cent last year due to the low investment appetite of industry. Retail credit (read home loans) has been the silver lining but with every bank piling up large retail exposures, concerns on asset quality are cropping up here too. In any case, the flood of CASA deposits from demonetisation by itself should bring down rates without the RBI having to act.

One other positive offshoot of this liquidity, even if one-time, is the treasury and trading gains on banks’ securities portfolios due to plunging yields.

But the key to reviving the long-term profitability of banks rests in the growth of credit, which is a function of a larger set of macro variables than just interest rates.

Another constraint will be capital — under Indradhanush, banks were to raise around ₹1.1 lakh crore from the market, while Government was to infuse ₹70,000 crore as capital over four years. But with their performance indicators at a low, both capital and market borrowings look challenging. Another look-out for 2017 would be the expected roll-out of the payment banks and the small finance banks.

Payments banks had a shaky start with dropouts and it remains to be seen when the rest will commence operations given the changes that have since taken place — demonetisation and the introduction of unified payment interface (UPI) have raised further question marks on their viability.

As to small finance banks, only two of the 10 commenced operations; the key question for the rest will revolve around how quickly the cash-intensive micro-finance sector adapts itself to the post-demonetisation economy, because these players are all erstwhile MFIs that have transformed themselves into banks.

For banking in particular, the SBI subsidiaries’ merger will be watched, while the long-due IFRS standards, in their unlikely event of being introduced next year, could be momentous for the banking system.

The writer is an independent consultant

COMMENT NOW