PSU Bank Mess & ‘Acche Din’ Ahead

The P Factor of NPA Mess: the past, present and future

Joydeep R Ray goes through the pages of history of NPA menace and finds hardly any political outfit can claim innocence when it comes to milking public sector banks to extend advantage to a section of ‘wilful defaulters’, only to book profit in some other way 

Passing the buck syndrome has taken absolute control of the politicians in India these days over the burning issue of rising NPAs in public sector banks—a whopping amount of Rs 3,41,641 crore calculated till September 2015 even after writing off bad loans worth Rs 1,14,182 crore during 2013-15.

While ruling BJP leaders including union Finance Minister, Arun Jaitley has blamed the earlier UPA government and its Finance Minister, P Chidambaram for the NPA mess, Chidambaram in turn claimed in the year 2000 when Atal Bihari Vajpayee was holding the office of Prime Minister of the country, situation was worse with gross NPAs touching a record high of 14 per cent.

BJP spokespersons in the national capital these days are running from one television news channel studio to another communicating popular anchors that none other than UPA government had given undue favours to poster-boy of NPA mess, Vijay Mallya. Congress leaders are not shying away claiming it all started with Vajpayee was running the government way back in 2000. While all these have been leading to exchange of hot words among the parties’ leaders, top management of ailing PSU banks pass the buck to their predecessors. Lakhs of individual investors who have invested their hard-earned money in the stocks of these troubled PSU banks, however, can’t pass the buck to anyone except blaming their luck.

In two phases since 1969, banks were nationalised with the objective of serving common people better and helping the industries to get a quick helping hand during their business activities. The PSU banks were spearheading their operations till 2008 and burdens of NPAs continue to go up since 1985 but the consecutive Finance Minister and Governors of RBI preferred to remain silent for reasons best known to them.

During the year 2008, these banks reported NPA worth Rs 53,917 crore and shockingly, the NPA basket went up to Rs 3,41,641 crore seven years later. Interestingly, till 2008, private banks in India topped the list with high NPAs which changed during those seven years. There started the politics over rising NPA and falling health of PSU banks. During September, 2008, ICICI Bank topped the list of banks with high NPAs closely followed by Karnataka Bank, Lakshmi Vilas Bank and Kotak Mahindra Bank. A quick look on available statistics reveals, during end of fiscal year 2013-2014, Central Bank of India topped the list of the banks with high NPA and it was closely followed by Dhanlaxmi Bank, State Bank of Hyderabad, Allahabad Bank and State Bank of Mysore.  Few months later when Narendra Modi led government settled down after achieving landslide victory in 2014 general elections, Indian Overseas Bank was topping the list of banks with high NPAs. IOB was followed by Dhanlaxmi Bank, UCO Bank, Bank of Maharashtra and Bank of India. This is even after waiving off bad loans worth Rs 1,14,182 crore during 2013-2015 when change of guards in the Centre took place. Shockingly, during 2004-2015, bad loans worth Rs 2.11 lakh crore was written off by these banks. So one thing is evident, whosoever came into power in Delhi, irrespective of political affiliations, they exploited the PSU banks.

“I think there were two types of act of negligence in the past—one, RBI allowed the problem to grow undetected and secondly, when attention of the government was drawn to the NPA mess, it did very little structurally, they did very little fundamentally and therefore, today, we have the situation where the economy and economic growth is really being held back by this significant problem in the public sector banking,” Rajeev Chandrasekhar, independent MP and industrialist, told DSIJ during a telephonic interaction. It is evident that RBI did not do much till the present governor, Raghuram Rajan helped the banks to wake up from their long slumber and forced those PSU banks to come up with transparency and that is when the cans of worms opened up.
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“How come Congress leaders blame NDA government for the mess, especially when Chidambaram as Finance Minister during UPA-1 had tabled the union budget with his opening remark appreciating sound economy that NDA government had left for him and the country! Today it is clear that wilful defaulters like Vijay Mallya were extended such undue advantages by the then Congress ministers in the Centre who had arm-twisted the PSU banks forcing them to grant loans to erring industrialists even though they even failed to furnish proper securities against the loan,” Secretary of BJP, Rahul Sinha said while talking to DSIJ.

But then the big question is why bad loans worth Rs 1 lakh crore was written off by the new government soon after it took charge in 2014. “As many as 17 banks were trying to recover dues worth Rs 9000 crore from Mallya and during 2013 when Chidambaram was Finance Minister, actions were initiated against 30 such defaulting entities including Kingfisher Airlines—and in 2016, Mallya finds an opportunity to escape the long arms of law suddenly when media started talking about NPA menace. Is it not surprising and can he manage to leave this country with seven huge bags from country’s busiest airport without help from the government,” Priyanka Chaturvedi, Congress spokesperson said. “Even CBI director told media that these banks and government did not come to the agency filing cases against such wilful defaulters. So it is clear now who is guarding whom,” she raised fingers on the ruling government. Question is how come suddenly during 2009-2014, the NPAs of the PSU banks witnessed such a steep rise unless government banks were asked to ‘help out’ some of these wilful defaulters! “UPA government not only created a Mallya but many other Mallyas during those five years. Now that agencies like CBI and ED have initiated probe, soon you will get to know names of the Congress leaders who had pressurised the state-run banks to disburse loans to Mallya and many others,” adds Sinha of BJP.

So what are the options that these banks have at this time—will laws help them to get their money back. “It is important to understand that laws are not the only solution to this problem. It all started due to a certain set of slackness and culture in our banking system that has caused to lending of this kind, atrocious! The lending system which has created such huge NPAs, lending without a proper system in place, lending which is crony capitalist in nature, lending of a dubious kind, ill-informed and say not very smart lending—we need checks and balances in place and those need to be implemented too,” said Chandrasekhar who had been vocal in Parliament since 2012 on the NPA menace. “No country in the earth would have 27 banks in public sector where government itself is the owner. So this budget has signalled consolidation, mergers and restructuring of public sector banks and it may pave the way for bringing things in control, at least to start with,” opined Dr Bakul Dholakia, former Director of IIM-A.

Another valid question comes up at this moment of crisis and transition—is there a need for a supreme or umbrella regulatory body to handle the health of these PSU banks in reference to their handling credits and rating of the same. “The multiplicity of regulators has necessitated the need for inter-regulatory co-ordination. It has become necessary for policy makers to look at the fact that there are apprehensions about regulatory arbitrage taking advantage of lack of co-ordination among various regulators,” point well taken by global consultancy, PwC. “See now we suddenly realise, most of these banks actually have no registered parents—one side they have their top management to govern the bank, then RBI, then Finance Ministry and a whole rank of bureaucrats. There is a need to fix the parenthood and work out a direct reporting system and a day to day monitoring by RBI,” said a former banker, requesting anonymity.

But then were these banks waiting for a Vijay Mallya to happen—“none really cared in their government since they came to power two years back. This government is more keen to holding big-ticket events rather than addressing problems. It is a government run by event managers and PR firms, why would they bother for the small investors who have their money at stake in these banks’ stocks. Mallya episode which was first legally tackled during UPA-II also did not attract attention of NDA law-makers till media raised this issue,” alleged Chaturvedi of Congress. “Wild allegations against us by the opposition. It is our government which opened the pandora’s box and work has begun to bring back these banks’ balance-sheets to normalcy and start afresh keeping in mind a stable health of the country’s economy and same of the investors,” added Sinha.

During all these days of passing the buck syndrome and blamegame, none has yet come out with a concrete solution, none of the political outfits, their leaders or even the government. As Raghuram Rajan believes, the situation needs a deeper, penetrative medication, not just some superficial healing procedure-time has come the government in Delhi has to take some proactive steps in addition to setting up a Bureau or Board, may be the steps should come from the Prime Minister’s Office, so that banks have no issue implementing those cutting all the red-tapes. After all, Modi believes more in rolling red carpet.
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Why the private sector banks remain a better bet

Karan Bhojwani looks through the balance-sheets and assets’ quality of Indian private sector banks and their PSU counterparts. He finds, private sector banks’ stocks still remain ‘safer’ to stay invested with even in these days of banking crisis being widely talked about

Financial specialists over the worldwide are raised with a philosophy that diversification is important rule to follow for a successful portfolio. They are additionally raised on conviction that the banking stocks should form a core part of our portfolio. The justification is that the business of money-lending is a simple one to comprehend, there is no deficiency of demand and with the globalisation, the extent of chances for development is vast. It has been over and over highlighted that the financial sector is an intermediary for the whole economy. Be that as it may, of late, the banking sector, particularly the public sector banks have neglected to bring cheerfulness on the investors’ face and this sector has been the feature for all the wrong reasons like the NPAs concern or the Vijay Mallya mess and it doesn’t end here, in yet another jolt to the PSU banks of late the rating agency CRISIL has downgraded 8 banks over asset quality issues.

Of course, the issue of asset quality has always been there and what this downgrade has done is to highlight the more vulnerable among the PSU banks.  The 8 banks whose debt has been downgraded include Andhra Bank, Bank of Baroda, Bank of India, Canara Bank, Dena Bank and IDBI Bank. According to rating agency CRISIL, significant stress in the corporate loan book of the public sector banks (PSBs) is likely to result in their weak assets expanding to Rs 7.1 trillion by March 2017 from around Rs 4 trillion as on March 2015. This will result in the weak assets ratio going up sharply from 7.2 per cent to 11.3 per cent. Most of these NPAs are coming from stressed sectors like steel, power and infrastructure. In all these sectors, there is no immediate visibility of any recovery, which could only deteriorate the problem for these banks.

Is this something new for the PSU Bank’s or is it in the roots that these PSU banks are constantly linked to scams?

History has a story or two to tell us and it is just about two decades back in the year 1992, which is known as the year of the stock market scam, the poster boy for many investors known as ‘Big Bull’ Harshad Mehta exploited the PSU banks to manipulate the stock prices. He took the price of ACC from 200 to 9000. That’s a whooping appreciation of over 4000 per cent. Be that as it may, unavoidable issue was the place Harshad Mehta was getting his perpetual supply of cash to rig the prices. The system through which the trick was influenced was the Ready Forward (R.F) Deal. Now you may wonder, what is RF? The Ready Forward is fundamentally a secured short-term (ordinarily 15-day) loan from one bank to another. Generally, put the bank loans against government securities pretty much as a pawnbroker loans against jewellery. The acquiring bank actually sells the securities to the lending bank and buys them back at the end of the period of the loan, typically at slightly higher prices. It was this mechanism used to generate the flow of money from the banking system. For the most part, the intermediary (broker) handles neither the cash nor securities in the RF Deal; however, that wasn’t the situation ahead of the pack up to the trick. In this settlement process, deliveries of securities and payments were made through the broker. That is, the seller handed over the securities to the broker, who passed them to buyer; while the buyer gave the cheque to the broker, who then made the payment to the seller. In this settlement process, the buyer and the seller might not know even whom they had traded with, either being known only to the broker. This the brokers could manage primarily because by now they had become market makers and had started trading on their account. To keep up a semblance of legality, they pretended to be undertaking the transactions on behalf of a bank. Another instrument which was utilised in a big way was the Bank Receipt (BR).  Alongside Mehta, the names included in the trick were the nation’s key public sector bankers- top treasury authorities at the State Bank of India (SBI), National Housing Bank (NHB) Chairman Manohar J. Pherwani and UCO Bank Chairman K. Margabandiu.  According to the information the year 1992-1993 the gross NPAs as rate of total assets remained at 11.8 per cent which is highest.
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At present, it’s not Harshad Mehta who has made the anxiety to the PSU banks transferred to its balance sheets. This time it’s the White Collar Corporates which have set the NPAs rising like a flame. With State Bank of India (SBI) declaring Vijay Mallya a wilful defaulter, the King of Good times has extraordinary obligation up to the tune of Rs 7000 crore. In any case, the worth of all the assets pledged together may not even touch an Rs 200 crore mark. That means there was some loophole in the banking system and this was utilised to make gain without having much securities to produce in case of a default in payment. The nature of collateral that has been offered by the borrower highlights the escape clause. Aside from aircraft and real estate, there is colossal pledge made against the brand and trademarks of Kingfisher. The issue of loaning against such impalpable collateral is that the worth reduces quickly when the brand sinks. For instance, the brand, logo and trademark of Kingfisher which was esteemed at sky high price, at present it must be close to zero. Likewise, resources like aircrafts have a restricted resale value. Similarly, back in 1992, Harshad Mehta hit the banking system unsportsmanlike by exploiting the loopholes.

What PSU Banks can learn from the Private Sector Banks?

In the third quarter ended 31^st December, 2015 the private sector banks posted a decent performance and emerged as a champ in spite of developing Gross Non Performing Assets (GNPAs).  While, the PSU Banks are under extreme pressure and have reported misfortune above than business sector desire.

Post the Q3FY16 declaration, considering a better than average surge in profitability of private sector lenders, India Ratings, in its February note, kept up a stable rating for private sector banks. However, for Public Sector Banks, the agency labelled a stable to negative sectoral viewpoint for FY17.

In a slowdown economy, it is common to expect NPAs will surge. However, as of late, it has been watched that the essential cause of rising NPAs was not related to slowdown but more of deficiencies in the credit and recovery mechanism. In fact, there could still be another element that is the procedure followed in extending and monitoring credit, for which there are critical contrasts in the methodology of public sector division bank and private sector banks.

For example: The private sector lender ICICI Bank did a keen work as it succeeded to slice their debt exposure on time to the Kingfisher group. The private sector bank offloaded its whole of Rs 430 crore debt exposure in Kingfisher Airlines (KFA) to a debt fund of Srei Venture Capital (SVCL); the fund management arm of Kolkatta based Srei Infrastructure Finance. That was to a great extent because of insightful early cautioning framework in view of thorough checking framework and market intelligence. Truth was that the carriers was making misfortune from the very beginning and the problem faced by the carriers had started appearing even to the casual observes as early as in 2010. What was unexpected to the instance of Kingfisher was that a handful of public sector banks kept on loaning the obligation ridden airline even after the carriers lost its flying permit in mid-2012 and inevitably twisted up its operations. If the PSU banks were effectively observing and had put a legitimate mechanism of early warning system, this humiliation would have been restricted to a lower quantum. 

How can PSU banks become more efficient?

‘Winners don’t do different things, they do things differently’ as quoted by Shiv Khera. In almost every parameter, private banks are displaying better performance than their peers in the public sector and their market share has been growing. The PSU banks need to do things differently to stay away from emerge of such circumstance in future. The PSU banks need to rebuild its administrative and operational self-rule. Give the banks a chance to pay aggressive bundles for their chief, let them recruit quality ability at an expense and recruiting should not be restricted to recommendation i.e. ‘Sifarish’ in Hindi. Quality talent will bring in high quality skills and this will result in higher productivity. In the past we have seen the PSU Banks are excessively tolerant while recapturing the loans, they simply pronounce them wilful defaulters and this set as a terrible example. However, late steps taken by SBI and other PSU banks to recover loan from the defaulter i.e. Kingfisher (KFA) is the right approach embraced according to the circumstance and this ought to be proceeded and strict laws must be framed to maintain a strategic distance from such circumstance in the future.

Another important factor which depresses the performances of such government handled banks, is, too much political interventions. Experts believe that some of the huge loans disbursed to many ‘wilful defaulters’ are result of political pressure on the PSU banks. In fact, hardly there is any political outfit in India which did not try to woo the state-run banks for meeting vested interests of certain industrial houses. End result, we can see in today’s poster-boy Mallya controversy.

Considering this, strict norms should be set up to evade political obstruction in the operation of the banks. The PSU banks should adopt a more organised borrower screening, credit evaluation and post-disbursement supervision.  These measures will definitely help the PSU banks to register performance of high calibre and match step for step with the private sector banks. Such changes, once brought in, will help the investors to continue having faith on PSU banks’ stocks and they will keep gaining from such investment decisions.
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PSU banks’ stocks look attractive at this time, but the mess is depressing

Even Chirag Goti and Mayuresh Deshmukh agree with RBI Guv, Raghuram Rajan that a deep surgery indeed is needed when it comes to the banking scenario in India. They justify the recommendation here:

Amidst the shackles of a dilapidating global economy, the Indian economy is plagued with a depressive banking sector, posing as a hindrance towards the elicit goals set by the NDA government. More than two dozen Public Sector Banks (PSBs) in India have been in bad shape for a while now, thanks to an overload of bad loans, which are close to topping Rs 3.6 lakh crores. This is a huge jump in comparison to the figures as on March 31, 2015 standing at Rs 2.67 lakh crore. These PSBs wrote off a total of Rs 1.14 lakh crore of bad debts between financial years 2013 and 2015, much more than they had done in the preceding nine years. At the same time PSBs have reported a cumulative loss of Rs 11,000 crore, in Q3 FY16, as against a net profit of Rs 10,000 crore, in Q1 FY16. Other related sectors may be dealt with an unfavourable blow as a consequence of the dilapidation of the banking sector. A banker should be very cautious while lending, as he is not lending money out of his own capital. A major portion of the money lent comes from the deposits received from the public and government share. At present high levels of Non-Performing Assets (NPAs) in the banking sector is an issue of concern and its constant appraisal may lead the economy to the state of a major crisis.

Reasons for growing NPAs in the current perspective

The NPAs on bank balance sheets did not make an appearance overnight. There is a blend of various factors, which we shall now discuss:

Main reasons for increase in NPAs of banks, inter-alia, are sluggishness in domestic growth, of late; slowdown of recovery in the global economy and continuing uncertainty in the global markets leading to lower exports of various products like textiles, engineering goods, leather, gems; external factors including the ban in mining projects; delay in clearances affecting Power, Iron & Steel sector; volatility in prices of raw material and the shortage in availability of power have impacted the operations in the Textiles, Iron & steel, Infrastructure sectors; delay in collection of receivables is exerting strain on various Infrastructure projects; and most importantly aggressive lending by banks in past.

The UPA government was exercising a considerable amount of influence on all public banks. It appointed all the officials and members of board of banks, and in fact, the government itself was represented on their boards by senior officials of the Finance Ministry. Without the tacit agreement of the government, the large loans bailed out by these PSBs could not have been a possibility.

Under a model of PPP Infrastructure development in India, private players bid aggressively at commercially unviable terms. To execute these projects, they have taken high debt from the bank rather than to raise the finance through equity, due to an assumption of getting higher valuations on completion of the project, when uncertainty is lower and rewards are nearer for investors. But, as is painfully typical in India, projects are inevitably delayed due to stalled procuring permissions, clearances and land acquisition. Therefore, these private players trap with high leverage, and moreover, interest costs shoot up drastically by this time, further eroding profitability. Low cash flows lead to more delays and the vicious cycle continues.

Unfriendly bankruptcy laws-it takes on an average four years to completely exit an insolvent company, which is extremely inefficient as per global standards. This delays the sale of company assets and clearing of debts to the creditors including banks.

Gross NPAs of public-sector banks rose to 6.15 per cent as of September 2015, from 5.20 per cent in March 2015. RBI has asked banks to review certain loan accounts and their classification over the two quarters ending December 31, 2015, and March 31, 2016. We have already seen a huge spike in NPAs, and post the March quarter results, the level of reported impaired assets for these weaker banks will likely go up further.

The bank’s entire machinery would be pre-occupied with recovery procedures rather than concentrating on expanding business. A bank with a high level of NPAs would be forced to incur carrying costs on non-income yielding assets. Other consequences would be reduction in interest income; high level of provisioning (as banks are required to keep aside a portion of their operating profit as provisions, as NPAs increase banks have to increase the amount kept aside as provisions which will reduce their net profits); stress on profitability and capital adequacy; gradual decline in ability to meet steady increase in cost; increased pressure on Net Interest Margin (NIM) thereby reducing competitiveness; steady erosion of capital resources; and increased difficulty in augmenting capital resources. NPAs reduce earning capacity of the assets and as a result of this, ROA (Return on Assets) gets affected. While calculating Economic Value Added (EVA =Net operating Profit after tax minus cost of capital) for measuring performance towards shareholders’ value creation, cumulative loan loss provisions on NPAs are considered as capital. Hence, it increases cost of capital and reduces EVA. Due to NPAs, yield on advances depicts a lower figure in comparison with the actual yield on “Standard Advances”.

Action taken by the RBI and government

In July 2014, the regulator introduced the 5/25 refinancing norms which allow banks to extend the tenure of loans given to infrastructure firms for up to 25 years.

In June 2015, the RBI introduced Strategic Debt Restructuring (SDR) norms wherein banks are allowed to convert their debt to majority equity in a borrower firm, through which they could effect a change in management, where necessary.

In early December 2015, the RBI has announced a change in the base rate calculations for the banks, effective from April 1, 2016. RBI has now introduced a more complex MCLR (Marginal Cost of Funds Lending Rate) replacing the base rate earlier. With this, RBI is now introducing a tenor-premium-linked term structure of MCLR, which will serve as the basis to arrive at the lending rate.

In Union Budget 2016, in order to promote the business of asset reconstruction in India, Finance Minister, Arun Jaitley increased Foreign Direct Investment (FDI) cap on asset reconstruction companies to 100 per cent from 75 percent under the automatic route. This is a big enabling provision for ARCs which are struggling for funds as banks refuse to give steep discounts on the stressed assets and the ARCs have to make an upfront payment of 15 per cent of the cost of the asset.

RBI has relaxed norms relating to the treatment of certain balance-sheet items, including property, which will help banks, especially the PSU banks to expand capital base to meet Basel III norms. The amendments stated below allow banks to beef up its capital adequacy by including certain items such as real estate assets, foreign currency assets and deferred tax assets to be counted while calculating Tier-1 capital; but only the discounted value can be taken into account.

Major amendments are: A) Revaluation reserves (only 45 per cent of the total) arising from change in the book value of a bank’s property on its revaluation would be considered as common equity tier 1 capital (CET1) instead of Tier 2 capital. B) Foreign currency translation reserves (only 75 per cent of the total) arising due to translation of financial statements of a bank’s foreign operations to the reporting currency can be considered as CET1 capital.  C) Deferred Tax Assets (DTA) arising due to timing differences can be recognised as CET1 capital up to 10 per cent of a bank’s CET1 capital.

According to RBI sources, this move would help in unlocking Rs 30,000-35,000 crore of capital for PSBs and up to Rs 5,000 crore for private banks. 

To provide some relief to the public sector banks under the yoke of extravagant NPAs, or bad debts, Jaitley allocated Rs 25,000 crore for their recapitalisation in the Union budget 2016. Going forward, Jaitley plans to provide Rs 25,000 crore capital during 2016-17, while Rs 20,000 crore would be provided during 2017-18 and 2018-19.

The government also is considering mergers between bank subsidiaries and even between weak and strong state-owned lenders.

Way forward:

RBI and PSBs are finally willing to acknowledge the problem which is a good sign, however it doesn’t mean the issue is resolved. Hidden NPAs of banks have been a bigger concern for the regulator as against the declared ones, since no one had actual estimate of the extent of bad loans in the banking system. How to repair such a huge stock of bad assets is a big question before the industry, the government and the regulator. "Deep surgery needed to clean up balance sheets; NPA recognition is anaesthetic to do surgery," comments RBI governor, Raghuram Rajan.

More skeletons will tumble out of the closet when banks fully declare the NPAs in their books. The earlier latitude that banks used to enjoy for pushing bad assets into the restructured loan category is no longer available now, since the RBI has asked banks to treat fresh restructured loans at par with bad loans.

You might find PSU banks’ valuation attractive at current stage, but the uncertainty element is too high which is resulting in trading at a huge discounted Price to Adjusted Book Value (P/ABV), which is the valuation parameter that is widely followed by the market, however no one knows how much to adjust a bank’s book due to hidden NPAs in the books of these banks.

Public sector banks will now take at least a year to write-off NPAs and also to recover from the current low credit growth. Any chances of recovery depend on the revival in the economy itself and how effectively the banking system is equipped with tools to take on crony promoters, who have been using the banking system to their advantage. That will be a key driver for growth in the sector. A strong and robust bankruptcy code will catalyse the government's reform process for the banking industry as it will help in unlocking the unproductive capital stuck in the economy.
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See changes in outlook of the banking sector by end of FY17

Lohit Bharambe believes all that is not bad with Indian PSU banks and he believes things may change for good in a year’s time from now.

Indian banking sector is pursuing the issue of bad loans, from a considerable period of time. The ballooning Non-Performing Assets (NPAs) are hampering banking profitability, which in turn is affecting the overall economy.

According to the government, the total stressed assets of the banking system stand at Rs 8 lakh crore, which comprises of restructured loans and NPAs. Out of total stressed assets, the distribution of NPA and how much of it will be provisioned will be taken care of by each bank, individually.

The government will infuse additional capital over and above Rs 25000 crore as per Union Budget 2016-17 to ensure that the banks are adequately capitalised. As per RBI, the total bad exposures of banks, including rescheduled and written-off assets, was 17 per cent of deposits as on September 15 last year, up from 13.4 per cent in March 2013.

The Reserve Bank of India (RBI) intervened after realising that the banking NPA problem is grave. The Central Bank has requested banks to increase provisions for covering bad loans in the second half of FY16. The consequences of eroding bank provisions have hampered profitability of many of the public sector banks in Q3FY16. There is more to come in the last quarter of current financial year. These steps may severely impact the bottom line of banks.

The RBI governor Raghuram Rajan is taking effective steps towards its goal to clean bad loans by the end of FY17.  The banking regulator wants banks to complete the process of identifying and providing for existing stressed assets.

The RBI has also directed banks under Basel III requirements to maintain a common equity tier-I capital ratio of 5.5 per cent for the current year, which is a bit higher than 4.5 per cent, required internationally. This window may be used by RBI to provide assistance for the banks.

According to RBI’s capital relaxation policy, the banks are to help meet Basel III norms that will provide additional capital to banking industry. The higher capital infusion is going to provide big relief to banks that have been struggling with advanced NPA issue. As per the new rules, the banks will be allowed to recognise real estate assets; foreign currency assets; and deferred tax assets as capital, with appropriate restructuring.

The banking sector’s balance sheets are in a dismal state for the past couple of fiscal years. As a whole the investors, depositors and lenders confidence is at stake when increasing NPA ratios. There will be a steep rise in provisioning of stressed assets in comparison with the standard assets. The incremental NPAs have direct exposure towards the profitability of the banks.

The increased NPAs put pressure on recycling of funds and reduce the ability of banks towards increased lending. The banks may earn from lesser interest income. It contracts the cash stock which may lead to an economic slowdown.

The banks are trying to maintain a balance by issuing lower interest rates on deposits; and on the other hand are likely to charge higher interest rates on advances to sustain Net Interest Margin (NIM). This may prove to be an obstacle in the smooth flow of financial processes and is a hindrance to bank’s business, eventually stalling economic growth.

On account of adverse financials of the banks, the shareholders are not receiving a market return on their capital and sometimes it may erode their value of investments. The banks whose net NPA level is 5 per cent and above, are required to take prior permission from RBI to declare a dividend. The banks also have to specify a limit on dividend payout.

As a matter of fact, the incremental NPA has a cascading impact on all major financial ratios of the banks, such as NIM, return on assets, profitability, dividend payout, provision coverage ratio, credit contraction etc., which are likely to erode the value of all stakeholders including shareholders, depositors, borrowers, employees and the common public at large.

On financial front, the banking sector is not performing well and hence the overall economy is under pressure for delivering the numbers. Considering a major chunk of the public sector banks, the cost of liabilities has been increased from 4.5x times in FY05 to 6.1x times in FY15. The interest spread, which is the difference between the average lending rate, and the average borrowing rate for a bank, has declined and stands at 6.21, which is on the lower side in comparison to last decade’s statistics. The public sector banks’ ROA (Return on Assets) has a declining trend and stands at 0.45 per cent, while ROE (Return on Equity) has reduced more than twice from 20.5 per cent in FY05, to 8.82 per cent in FY15.

Not overlooking the fact that private banks have delivered steady financial performance as compared to public sector banks, these private sector banks’ cost of liability remained intact at 5.87x times; the ROA and ROE ratios stand at 1.69 per cent and 16.06 per cent, respectively, in FY15.

Most of the public sector banks reported net loss in Q3FY16 which was a historical set of events. From the past 15 years, public sector banks have never reported a net loss in the quarterly results. The primary reason behind the net loss is the declaration of bad loans according to RBI guidelines. These public sector banks have reported a net loss of Rs 11265 crore in Q3FY16. Meanwhile, the private sector banks have reported a net profit of Rs 12133 crore in Q3FY16.

For the last quarter of current fiscal year also, we may stand witness to some shocking numbers. India’s largest bank State Bank of India has stated that there will be an increase in NPA numbers in Q4FY16. Most of the research houses have predicted that the Indian banking industry’s bad loans will touch Rs 5.3 lakh crore, which is about 6.3 per cent of total advances, till the end of FY16.

The banks which are writing off the stressed assets, intend to keep low deposit rates and maintain high lending rates. The banks are trying to recover losses pertaining to the bad loans by maintaining an adequate balance between lending and deposit rates.

The banks write off NPAs on regular basis for cleaning up their balance sheets. The primary motive behind the process is to clean balance sheets and achieve taxation efficiency. As for the written off accounts, loans are written off from the books at the Head Office, dissolving the right to recovery. Further, write offs are generally carried out against accumulated provisions made for such loans. Once recovered, the provisions made for those loans flow back into the profit- and- loss account of banks.

As per the RBI report, stressed assets including bad loans & restructured loans would be around 11 to 12 per cent of the total bank loans given. Currently the amount of bad loans written off by public sector banks is more than Rs 2.11 lakh crore between the period of 2004 and 2015.

During the Gyan Sangam for year 2016, The Finance Minister stated that the NPAs of banks would not affect the government’s decision to restore the health of banks. The upcoming second half of the budget session would pass the most awaited bankruptcy and insolvency bill which will help banks to recover bad loans faster. Though there is a long way to go for consolidation of public sector banks, since the government is taking appropriate measures, streamlining of bad loans will be progressive in the forthcoming year.

Conclusion:

The outlook for the banking sector is going to improve till the end of FY17, attributed to the standards set by RBI, and the integral step taken by the government related to cabinet capital infusion for releasing banks of stressed assets. The shareholders’ wealth creation process has suffered enormously since the past one year. The long term investors will definitely keep faith in the banking system of the country, which in turn will deliver good returns in the days to come. The government is certainly striving hard to revive the banking sector, putting in place mandatory reforms and patience is all that investors need for reaping rich benefits!
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Merger may not be as effective as being canvassed

A keen observer of Indian banking sector, Abhishek Kumar talks about the present, future and further road ahead for the PSU banks 

The present

Banking sector in India at large has been reeling under tremendous pressure these days courtesy ‘bad loans’ on their balance sheets of all the lenders, be it the PSUs or the private sector lenders. However, private sector at large has been shielded to a large extent except for a few exceptions like ICICI Bank which has been a laggard amongst its peers.

But the real pain points have been the state run lenders which is seriously hurting the financial stability and growth prospects of the country’s economy. Indian banks' stressed loans are at a 13-year high of USD 119.12 billion, constraining banks' ability to lend and further boost the economy.

Recent published Q3 numbers have reflected the mess which has been created in the financial system. Banking sector is grappling with rising Non-Performing Assets (NPAs), which are expected to rise further in coming quarters due to RBI directives to publish facts on bad loans. During the quarter, as a part of asset quality review (AQR) conducted by the apex bank, the banks have been advised to reclassify/make additional provisions in respect of certain advance accounts over two quarters ending December 2015 and March 2016. The banks have accordingly been implementing the RBI directions in this quarter gone by.

Taking the RBI directives seriously, Bank of Baroda, country’s second largest PSB in its recently Q3 earnings declared its highest ever quarterly loss in the entire banking history. The bank provided for its bad loans in the December quarter itself following RBI orders, unlike most other public sector banks which have decided to spread it over Q3 and Q4.

The entire concern surrounding NPAs and all related problems are not being handled well, which is having a major negative impact on the entire banking system which is reflective of the fact that total Gross NPAs of public sector banks stood at Rs 3.60 lakh crore for the quarter ending December 2015, up from Rs 2.67 lakh crore at the end of March 2015. It is highly possible that a few PSU banks are technically insolvent now.

There is an urgent need for a clean-up action of the entire banking system especially the PSU space as they account for more than 70 per cent of the total banking in the country, therefore if the economy needs to achieve ambitious growth targets going ahead, government and all the allied agencies need to take cognisance of the fact that it needs to strengthen the banks first, both financially and improve its governance process.

A systematic approach is needed here in order to clean up the banking clutter which has been present since quite long, though noticed and ignored for certain reasons best known to the bankers and country’s law-makers and even the keepers of the apex bank. Banks need to change with the dynamic needs of the economic environment of the country and financial markets at large. Banks needs to have an annual forensic audit of bank loans every year instead of doing it in times of emergency and sharing of information amongst all the banks about borrowers to avoid costly mistakes.

This banking trouble has highlighted one of the biggest gaps in the Indian banking system. Often one lender does not know what the another lender is facing. There is an absence of integrated database, which in turn makes it impossible for banks to establish how much a business entity may owe to other banks. Many times it’s been noticed that a borrower takes a loan from one bank to repay another. And when nothing works, such borrowers with not so good interests, resort to borrowing from what is termed as a ‘consortium.’

Furthermore, the credit evaluation system needs to go through some changes as domination of state-run banks often results in small ones relying on whatever leaders like State Bank of India and ICICI Bank decide. Banks need to go through a structural change and not just a cosmetic surgery.

Below are few changes which can be incorporated by the banks:

1.     The government and RBI must recognize the scale of the problem and declare all the stressed accounts and write-offs.

2.     PSU banks should sell their NPAs to asset reconstruction companies (ARCs) for cash at deep discount, if necessary and focus on giving credit.

3.     Disclosure of full and comprehensive information on the financial health of banks needed to be done on a regular basis. RBI should take a leaf out of methodology being followed in US and Europe where all the banks have to conduct an annual ‘stress test’ and disclose the results publicly.

4.     Government must lower its stake in the PSU banks. The ‘Indradhanush’ reforms are a good way forward.  In order to achieve some tangible benefits of the reforms push the government and policy makers need to sacrifice there long held belief of holding on the control of PSBs.

5.     All stakeholders must realise that commercial banking industry is undergoing a major transformation currently, driven principally by technological advancement. In order to stay relevant in the future and stay with times PSBs needs to adopt newer technologies and impart latest skill set to their employees. Unless PSU banks invest in cutting edge technology, it will be a difficult for them to move ahead.

The regulator i.e. RBI in this case and guardian of PSBs i.e. Government of India needs to work together on this mess instead of blaming each other. The institutions need to work like ‘Team India’ and not independently.

PSBs also need to spend highly on their employees HR needs and one step which can go on to benefit is giving ESOPs to bank employees which would make them more accountable and give a sense of belonging and purpose.

Owing to the changes made by the government in appointing PSBs chief, Bank of Baroda is now led by an experienced banker from the private sector. At present, only one other state-owned bank is run by a banker with private sector experience i.e. Canara Bank. More such changes need to be done on a priority basis. Making the appointment procedures more streamlined. Filling up of all the vacancies of PSBs in time so that they don’t remain headless for a long period of time which has been a normal practice of late.

Allowing public sector banks to go in for recruitment of best talents from the campus which is available to private sector banks. PSBs needs to hire talented workforce and train them in time as in coming years there would be many retirements taking place from these state run lenders. Chalking out a career succession path of the PSB chiefs and giving them a longer tenure would really help them in bringing desired changes in the overall culture of the bank concerned.

Right from govt. reducing its stake in all the banks below 50 per cent or at least reducing their stake in the top 10 lenders below 50 per cent. Selling of non-core business of the banks would help them unlock capital being tied up in business where the bank does not possess enough expertise to run the business.

The PSBs should not solely depend upon the government for capital infusion and should try to come out with other innovative ways to raise capital in order to remain in sync with the BASEL III norms and keep the credit offtake at a reasonable level.

Even the judiciary needs to get its act straight by disposing off the case on a priority basis which can be done by setting up of new commercial courts and debt tribunals. There is also a suggestion with regard to expediting the DRT (Debts Recovery Tribunal) process by some more amendments to the Act so that the recovery process gets fast tracked.

The government has done a right thing by constituting a Bank Board Bureau which seeks to reform the appointment process for top posts and improve governance at public sector banks. Vinod Rai, former Comptroller and Auditor General, there cannot be a better appointment than Vinod Rai him for the post which will also have six other members. Banks Board Bureau (BBB) is set to be put in place by April 1, 2016.
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Will macroeconomic initiatives help PSU banks in the troubled days?

Although discussions are still underway, future of the PSBs seems to be glorious, believes Abhijeet Gosavi

‘Make in India’ is an initiative of the Government of India to encourage multi-national, as well as domestic, companies to manufacture their products in India. It was launched by Prime Minister Narendra Modi on 25 September 2014. India would emerge, after initiation of the programme in 2015, as the top destination globally for foreign direct investment, surpassing China as well as the United States.

The banking sector will propel the ‘Make in India’ vision by providing funds to various industries involved in the initiative. The banking sector is in a completely chaotic situation from the past one year. The upcoming year too is action packed for the banking industry as the NPA mess is on radar.  Considering these factors, the ability of the banking sector in doling out funds, is what investors will be keeping a close watch on.

The banking industry will definitely benefit from ‘Make in India’ initiative in the long run. The realty and infrastructure sectors are the main defaulters as far as bad loans are concerned. In future terms, when these sectors will be infused with vigour and vitality, the banking sector too will be subject to an invigorating experience. ‘Housing for All’ is a step in the right direction towards reviving both the interwoven sectors that happen to be the driving force behind the growth of an economy.

The capital funding provided to the manufacturing industries will increase their lending portfolio. This capital which banks will provide to manufacturing industries will boost their cash flows, eventually providing a fresh lease of life to the overall economy.

There have been various political hurdles for surpassing investment limits in the insurance business. Recently, crop insurance has also been introduced by the government, a move that will arrange for new business, which the banking sector is in dire need of.

When domestic or foreign investors acquire a large shareholding in any bank and exercise proportionate voting rights, it creates potential problems, not only of excessive concentration in the banking sector, but also can expose the economy to more intensive financial crises at the slightest hint of panic. FDI (Foreign Direct Investment) within the banking sector can solve various problems of the overall banking sector. FDI brings along an array of benefits like technology transfer, better risk management, financial stability and better capitalisation.

The government has also permitted foreign banks to set up wholly owned subsidiaries in India. However, the cabinet has not taken any decision on raising voting rights beyond the present 10 per cent cap to the extent of shareholding. The new FDI norms will not apply to PSU banks, where the FDI ceiling is still capped at 20 per cent. Foreign investment in private banks coupled with a joint venture or subsidiary in the insurance sector will be monitored by RBI and the IRDA to ensure that the 26 per cent equity cap applicable for the insurance sector is not breached.

All entities making FDI in private sector banks will be mandatorily required to have credit rating. The increase in foreign investment limit in the banking sector to 74 per cent includes portfolio investment [i.e., Foreign Institutional Investors (FIIs) and Non-Resident Indians (NRIs)], IPOs, private placement, ADRs or GDRs and acquisition of shares from the existing shareholders. This will be the cap for any increase through an investment subsidiary route as in the case of HSBC-UTI deal.

Payment banks are considered as the next big thing in the banking space that is expected to change the entire landscape of the banking sector of the country. All the banks would be primarily technology driven in their operations without minimal physical presence, which would surely help change the age old banking protocol that entails many loopholes.

Payment banks can accept demand deposits and savings bank deposits from individuals and small businesses up to a maximum of Rs 1 lakh per account. NRIs cannot bank with these ventures, who in turn cannot disburse loans in a manner similar to the services provided to the traditional ones.

However, payment banks can sell mutual funds, insurance and pension products as well as facilitate payments and remittances with a focus on the unbanked segments such as migrant workers which constitute a large number.

The space has seen a spurt of activities in the recent past as all the 11 players gear up for setting up the infrastructure to run the banks. Players who have received in principal approval from RBI and do not belong to financial sector have forged partnership with banks and other financial institutions.

Alibaba backed PayTm which is one of the winners of the license is expected to be an aggressive player, giving in to the fact that its already successful digital wallet product along with its cutting edge technology would aid in implementing the Payment bank network further. PayTm has even appointed former central banker to run the payment bank division of the company. It recently was in final stage of offering outsourcing contract to a vendor.

The amalgamation of Public Sector Banks (PSBs) will have shared infrastructure, which in turn will give customers a wider use of the ATM network; and charges on cross-bank ATM usage would reduce considerably going forward. The customers would get access to wider use of financial instruments like mutual funds and insurance products that most of the big banks offer. The large banks would have a wider capital base enabling them to offer big ticket loans on their own without being part of a consortium.

According to shareholders’ perspective the collaboration of PSBs would not impact their holdings, as banks would perform considerably well, each bank getting its share of the pie. Meanwhile, according to major lending banks, they will not directly acquire the smaller banks, but ongoing NPA issue will be a major breakthrough. Although discussions are still underway, the future of the PSBs seems to be glorious, as a silver lining to the dark cloud looming over it at present.

All said and done the NPAs issue is getting sour and is pushing the Indian economy into unchartered territory. Meanwhile the latest developments in macroeconomic situation such as increment in FDI limit; ‘Make In India’ initiative by government; payment bank licenses; merging of public sector banks to ensure quality rather than quantity, will anchor the banking sector into a safe zone, which is what investors will take delight in as their waiting period will finally come to a halt, and they would start roping in a handsome ROI (Return on Investment). The government has put in place proper strategies; however, the ball is now in the court of the banking sector, as regards their co-operation in cleaning balance sheets and declaring hidden NPAs. It is indeed a long wait for investors before they actually see light at the end of the tunnel.
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Public vs Private-the real game is yet to begin

MSR Manjunatha, Director – Ratings, Brickwork Ratings India believes there is only so much that a private bank can snatch from a public sector bank and it is not surprising if the PSBs fight back for retention of whatever good business they have

As the sun shines bright in March heralding onset of summer, one area that is quite cold is the outlook for Indian Banks.  With Kingfisher Airlines making head-lines in newspapers – 3 years after it was grounded – and with MPs, TV commentators, and practically everyone asking how the Airline got so much money without collateral, and CBI threatening to unearth collusion of bankers with the airline promoters, the ‘cup of misery overfloweth’!  From an investor perspective, Public Sector Bank (PSB) stocks have nose-dived over the last one year, with SBI – the largest and better managed among the lot – falling by as much as  51%.  Less said about other PSB stocks, the better.

It is not all that gloomy – if you look at the performance of Private Sector Banks (PvSB). In fact, in each parameter that Analysts use to evaluate banks, PvSBs have far out-performed PSBs. In table 1, we have compared select PSBs and PvSBs, and the performance variation is quite glaring.  Given the fact that all banks – private or public – operate in the same economic and legal environment, what explains this glaring disparity in performance?  Is it about ownership, management, personnel, use of technology, risk management practices………?  Whatever could be the root cause, the visible issue is steep deterioration in asset quality in PSBs, the consequent impact on provision costs, profits and capital adequacy.

Deterioration in asset quality of PSBs started almost 3 years back, and has now culminated in steep increase in Gross NPAs and Restructured Loans by end of Q3FY16.  Lending to Infrastructure (comprising of Power, Roads and Aviation), and other core sectors or cyclicals like Steel and Textiles have added to the woes of PSBs.  Gems & Jewellery, Mining, Tourism (mainly Hotels & Resorts), as also commercial real estate sector have contributed to increasing NPAs.  Steps like Corporate Debt Restructuring only helped postponing the problem, but now with RBI exhorting banks ‘not to sweep any bad news under the carpet’, the true story is coming out.  Most PSBs have GNPA at 6 – 12% of total loan book, and total impaired assets (GNPA + Standard Restructured Assets) between 10 – 22%.  These are truly very high numbers, and the consequences are there for all to see.  Almost all PSBs have either declared losses in Q3, or steep fall in profits.  The situation is not likely to be better in Q4 for most of them, and they can be expected to skip divided for FY16.

Given this situation, it is only natural for the stock prices to decline.  Even as of March 2015, with ROA at 0.75% or below, and ROE at < 12%, investors were weary of these stocks.  They could not see any bright spots, and the P/BV for even a better performing bank like SBI was at 1.12 times.  Most PSBs had it at < 1.  Capital starved PSBs had to either look to the Government, or approach their traditional supporter like LIC.  Though the situation has only deteriorated as of December 15, stock prices have not taken further beating, probably expecting that bad days are shortly coming to an end.

Traditionally, PvSBs are classified into two categories – viz., the Old PvSBs (like Federal Bank, Karur Vysya Bank etc.) or New PvSBs (like ICICI Bank, HDFC Bank, Axis Bank etc.).  Both categories have listed banks. Given that the Old PvSBs have very low market share, this write-up has taken the performance of New PvSBs for further analysis.

Overall, PvSBs have steadily increased their market share, and as of FY15 it was around 21%.  Looking at the extremely low growth of PSBs in the current financial year (could be just ~ 5%), and the normal growth among the New PvSBs (around 12 – 15%), it can be expected that the PvSBs will cross 25% within the next 2 years.  This could happen even faster, if the PSBs – with their focus shifting entirely to delinquency management, recovery and staff accountability – start losing whatever good business they have, which is quite likely; then it is good news for the PvSBs.  They have not taken much exposure to the stressed sectors in the past, and have provided for whatever problems they had.  Hence, they can be expected to attract or retain good Corporates, Mid-corporates, SMEs, etc., who are looking for banks which can provide them need-based funding beside good service.  In any case, these banks are strong in Retail Lending, with the portfolio at 25 – 40% of the loan book, and there are no signs of any distress in this segment.  Their fee income is good, and yields from their investment portfolio better.  So, overall, these banks which have good technology platforms, prudent risk management practices, good capital adequacy ratios, and have tight control over their costs, can be expected to do well in the short to medium term.  Their ROA is > 1.5% and ROE anywhere between 15 – 20+%, and hence, attracts savvy investors.  Large market capitalisation of such PvSBs, and their weightage in various stock market indices is anyone’s envy.

However, a word of caution here would be appropriate.  Ultimately, the banking industry reflects the economy, and if the whole economy in India stagnates, that would be reflected in the performance of all the banks.  There is only so much that a Private Bank can snatch from a Public Sector Bank, and it is not surprising if the PSBs fight back for retention of whatever good business they have.  Then, either the private banks start slowing their growth, or their assets also start reflecting what is happening in the economy.  New entrants to banking like the Small Finance Banks or Payment Banks also may eat into some of their business segments.  But that is another 12 – 24 months away, and that is a long time for stock markets!

In order to bring out the clear performance variation between Public Sector and Private Sector Banks, BWR has taken certain average performance numbers for each set of banks. For this purpose, Allahabad Bank, Bank of Baroda, Bank of India, Canara Bank, Indian Bank, PNB, Syndicate Bank, Union Bank of India and State Bank of India are taken as representing Public Sector Banks and Axis Bank, HDFC Bank, ICICI Bank, IndusInd Bank, Kotak Mahindra Bank and Yes Bank are considered for Private Banking space. Old private sector banks have been left out of this analysis, considering their market share.