Banking Sector: Budget Expectations

The banking sector is one of those that have been buzzing on the investors’ radar for quite some time. The sector is confronted with a lot of issues such as capital infusion in the PSUs, deterioration in terms of the asset quality, expectations about interest rate reversal, etc. It was also under immense pressure over the last one year, evident from the fact that the stocks performed poorly on the bourses. This was due to the high interest rate regime which usually affects the banks in multiple ways. From the last budget till date, the Reserve Bank of India (RBI) has hiked the repo rate by 300 basis points to 8.50 per cent. This has put pressure on the banks’ net interest margin (NIM) and led to a slowdown in credit growth with individuals and corporates postponing their expansion plans.

As on December 30, 2011 the advances of the banks grew by 15.9 per cent on a YoY basis and a major factor has been the rising default on interest payment, thus deteriorating the asset quality. This has mainly been due to exposure to cash-trapped sectors such as power, aviation, textile, micro-finance, etc. The banks may continue facing pressure on their asset quality front and this will be reflected in the March quarter results of 2012.

On the positive side one could see the interest rate probably reversing from FY13. And it seems that the markets have started factoring this, as is evident from the performance of the banking stocks. This expectation has resulted in the banking stocks to rise sharply in CY2012. ICICI Bank has been up by 24 per cent in CY2011, HDFC Bank by 19 per cent, SBI by 33 per cent, etc. However, except for HDFC Bank and Kotak Mahindra Bank, the other banking stocks have underperformed in the last one year, as can be seen from the table below.

* Adjusted Stock Split

Previous Budget Targets

The announcements made in the last budget for the banking sector were:

• The finance ministry proposed to provide a sum of Rs 6,000 crore for the year 2011-12 to enable the public sector banks to maintain a minimum Tier 1 CAR at 8 per cent. This guidance was revised during the middle of the year as it was below the PSUs’ demand for capital infusion. As such, approximately more than Rs 16,000 crore will be provided by the government to the banks for FY12.
• Recapitalisation for the regional rural banks was increased from Rs 350 crore last year to Rs 500 crore for 2011-12. This was to help them maintain CAR of at least 9 per cent for FY12.
• The RBI would provide draft guidelines for the licensing of new banks in the private sector for FY12 in August 2011.
• Public sector banks to achieve a target of 15 per cent of the outstanding loans to minority communities (MSME) under priority sector lending at the earliest.
• Enhancement of the existing housing limit from Rs 20 lakh to Rs 25 lakh for dwelling units under priority sector lending. To further stimulate growth in the housing sector, it would liberalize the existing scheme of interest subvention of 1 per cent.
• A financial sector legislative reforms commission would be set up to rewrite and streamline the financial sector laws, rules and regulations and bring them in harmony with the requirement of a modern financial sector.
• Financial inclusion plan of providing banking facilities to all the 73,000 habitats having population of over 2,000 to be completed during 2011-12.

Current Budget Expectations

The banking sector’s expectations from the current budget are:

• Proper allocations of funds i.e. capital infusion for PSUs and regional rural banks will further help them to maintain Tier 1 CAR at 8 per cent and 9 per cent respectively.
• Allow banks to issue tax-free bonds as well as long-term Infrastructure bonds which will drive infrastructure lending and would also help the banks in managing their asset liability management. This would also, to some extent, help in developing the weak bond market.
• Provide more clarity and take a step ahead in case of new private banking licenses.
• Fiscal deficit being a pressing issue, the government may announce higher spending to fuel growth in the economy. On the other hand, it needs to have enough money to fund this expenditure. This will be done through higher market borrowings and through issuance of treasury bills. The government borrowing will put an upward pressure on the interest rates.
• More guidance on priority sector lending and on financial inclusion so as to drive the economy ahead.
• Clarity required for channelising the investments along with consistency of policy and the implementation of several key reforms.

Conclusion

The banking sector and the economic health of the country are integrated with each other. We believe that with the revival of the economy, banking players will also see good growth ahead. One of the important factors for the banking sector related to this year’ budget is the fiscal deficit target which will lead to government borrowings. This will have an impact on the interest rates too. Morgan Stanley has forecasted fiscal deficit at 4.9 per cent of GDP for FY13. Further, we believe that there would be higher capital infusion for PSUs as they would be requiring the same for growth as well as for maintaining their CARs.

The banks may be provided a higher target on the financial inclusion front as well as in terms of priority sector lending. With the Congress receiving a massive setback in the recently held assembly elections in states of UP, Goa and Punjab, one may see the FM introduce a more populist approach while presenting the Union Budget 2012-13. Any sort of loan waivers or any other common man-friendly reforms will severely impact the banking sector going forward.