At a meeting with analysts recently the top brass of the Corporation Bank pointed out that the reason for the squeeze in spreads for Indian banks in the second quarter was a unprecedented rise in competition for funds and as a result of cash flush public-sector units and other companies demand higher rates.

The average cost of funds has risen to 8.8 per cent in the current year so far from 8.5 per cent in the previous year.

This trend has acted as a major damper on spreads. Corporation Bank's spreads have come down from 4.4 per cent in the previous year.

This line of action has undoubtedly been behind the dismal performance of Bank of India.

The only silver lining for banks such as this is their refusal to accept deposits at very competitive rates which ensures an incrementalreturn on funds and a higher return on assets; representing a clean break from the earlier days where growth rather than return on assets meant everything to PSU banks and still does for some like Bank of India.

Despite the rise in the average cost of funds and a tightening of spreads Corporation Bank managed to raise its return on assets to 1.9 per cent from 1.87 per cent last year.

In addition as another measure of its performance the return on equity has improved to 22 per cent from 19.66 per cent.

Among a line of unfavourable results from banks this is still easily the best so far. The bank still maintains its enviable record of having the lowest proportion of net bad loans in the banking sector at just 2.77 per cent which is even lower than the 2.93 per cent achieved in March 1998.

Even its provisioning record is enviable; with 62 per cent of its gross bad loans of 6.92 per cent being accounted for; though this ratio has been declining over the last few years now from 78 per cent of gross badloans being accounted for in 1995-96 to the present coverage.

But loan recovery has been a major concern and its monitoring has taken on manic proportions at the bank.

The bank's management has admitted that the incremental lending is being restricted to the top corporates which may earn a lower return as funds will have to be loaned out at prime lending rate (26 per cent of its assets are lent out at PLR) but in turn will require lower provisioning.

HDFC Bank

HDFC Bank played up a sharp increase in the low cost demand deposits that it acquired in the first half of the current year.

At the time of its results the bank had said that low cost deposits had increased by 106 per cent YoY for the half year and between March 1998 to September 1998 there has been a 36 per cent rise in low cost deposits.

But this cannot really make a difference to the bank's fortunes in terms of average cost of deposits as these deposits form a very small portion of the banks funds.

The bank has said that thetotal deposits between September 1997 and September 1998 have increased by 52 per cent but unfortunately this growth between March 1998 and September 1998 is taken into account the rate of growth is negligible at under three per cent at Rs 64 crore. Now, even if this entire incremental deposit has been taken in the form of the low cost deposits the total available deposits will not exceed 8 per cent of total deposits or just Rs 180 crore.

The first half was bad for HDFC Bank with the damage being accelerated in the second quarter. Spreads are lower YoY with most of the fall coming in the second quarter reflecting the competition for deposits.

Almost the entire growth in net profit of nine per cent has come about due to a curtailment of operating cost as compared to the preceding period by a like amount.

The second half will only see an acceleration of the competition for funds and therefore a further squeeze on margins. The stock has begun to adequately reflect this fact and has fallen by roughly 20 percent, in the last couple of weeks.