Banking: Retro And Future Perspectives

Updated: May 19 2003, 05:30am hrs
What do the words Bankers Notice convey to you More likely, some jargon for another banking instrument. Maybe in todays context, you may conclude that it connotes potential action to be taken against a defaulter. But, this is, in fact, an acronym for some of the traditional concerns of all bankers: NPAs, overheads, treasury income, interest spreads, capital adequacy and earnings. Bank performance in any year can be measured by the extent to which these objectives are satisfied. We can go back into 2002-03 and try and see how these issues were addressed by bankers. Prima facie, it appears that things have turned out quite well for CEOs and the bonus cheques should bring in a smile if you are in the private sector and maybe a promotion if in the public sector.

Let us look at the bag of goodies to begin with. Net NPAs were down to 5.5 per cent in FY02 and gross NPA ratio was also down from 11.4 per cent in 2001 to 10.4 per cent in 2002. With the Securitisation law creating a storm rather than a flutter; the errant boys have started repaying loans. Never mind that the big guys have still gotten away and banks which have occupied properties of such companies are still trying to figure out what next. But, nobodys complaining now.

Overheads have started coming down thanks mainly to the VRS which was invoked a couple of years back in public sector banks, which account for 75 per cent of total assets of the system. Treasury income has once again come to the rescue of banks with gilt yields traversing a bottomless pit. The gilts market has boomed for another year and all doomsday soothsayers who felt that we had reached the end of the tunnel were proved wrong once again as treasury income has continued to rise this year as yields have fallen. The market has never had it better.

However, a more remarkable feature of banking is that they have managed to increase their interest rate spread on fresh deposits and loans. The simple current spread, defined as the difference between PLR and deposit rate on one-year deposit, was 3.5 per cent in 2001-02. By the end of 2002-03, it had widened to over 5.25 per cent points. This is amazing because if spreads have risen in a falling interest rate regime, banks have really played their cards well enough on incremental business. Or so it appears. It is not surprising that the RBI is still puzzled as to how or why lending rates have not come down for corporates while mortgages sell at sub-PLRs.

Banks are also well ahead of what the BIS has prescribed in terms of capital adequacy. There are only two public-sector banks and maybe one private-sector which are undercapitalised at below 9 per cent. This gives an indication that we are well on the path to meeting Basle 2 norms. Besides, with subdued demand for credit, capital has not been an issue.

Lastly higher interest spreads, windfall treasury income and lower operating costs have combined to boost profits of the banking system even though growth in business has at best been only stable. The results which will be announced by the end of this month by most banks will repeat this fairy tale.

Therefore, on the face of it, everything appears to be just fine. But, there are still some nagging issues which have to be confronted as we go along the way. The problem of NPAs has, in fact, not really been taken care of. In fact the situation is to get exacerbated once the new one-quarter norm for recognising an NPA is implemented after March 2004. How many banks have made progressive provisioning keeping in mind this compulsion Banks have so far not really overtly started moving towards this norm and while there are no estimates on the impact of this new definition, international agencies put our gross NPAs in the 20-30 per cent range which is not reassuring.

Secondly, as long as the gilt market is buoyant and the CRR and Bank Rate are being recklessly used to prop up the market, there is no fear of bank bottomlines being affected. The honeymoon with treasury profits cannot continue for long. This must ring a bell of deja vu because we have been saying the same thing for the last two years now and have been proved incorrect each time.

There are around Rs 4,00,000 crore of government paper in the non-held to maturity category. Assuming a duration of between four and five for banks, the yield has fallen by around 40-50 basis points (bps) in this year. This means roughly a profit of Rs 2,000 crore assuming that this paper is traded and a profit is booked. This year, the gain has been lower than what was earned last year, which really means that there is a feeling that interest rates have sort of plateaued out and things cannot get better. The fall in yield on a five-year paper was as much as 330 bps last year and came down to just about 40-50 bps this year. Banks would need to keep this in mind considering that the government is going to borrow Rs 1,60,000 crore next year and there could be steady demand for commercial credit. Also, inflation has started rising and the numbers are unlikely to be friendly this year.

Interest spreads are still very high by international standards. We have already seen that the simple spread has been widening, while the average spread for banks is still in the region of 2.8-3 per cent (defined as net interest income to total assets). Globally, banks operate with spreads of around 50 bps, which ensure fair-play with customers. With issues of higher NPAs and hence, higher provisions, lower treasury income, challenge in raising capital and higher technology costs (which are capitalised today), overall profits of banks would come under pressure.

The major pressure would be on the business front. Lower deposit rates will at some time militate against bank deposits. Banks have been undercutting each other on mortgages to capture a limited market share. Further, the shadow of Kelkar will fall sometime in future and housing as an investment proposition may lose its sheen. If gilt yields increase, then such investments may not be attractive. Demand for commercial credit could pick up and exert some pressure on banks again. These along with the constraint of capital adequacy will pose another challenge for banks. Are we prepared for such a scenario How many of our banks have plans to meet such contingencies

The author is an economist with Larsen & Toubro. The views expressed here are personal