The public sector banks are facing a Catch-22 situation. The current situation, where the private sector and foreign banks are on the backfoot because of the economic slowdown, may be providing a golden opportunity for PSBs to gain back their lost share in the Indian banking space. But the PSBs don’t see it as an opportunity and rather prefer to describe the situation as “bearing the crush” for propelling growth.

Most of the PSBs admit such a gain would not be without any risks. “Offering competitive rates for both borrowing and lending has a cost. I have to pay higher to mobilise resources and lend at lower rates to expand my business. Obviously it would hit my spread and and in turn my profitability. Why should I sacrifice my profitability for market share?” asked KC Chakrabarty, CMD, Punjab National Bank, rather bluntly. He is likely to elevated as the deputy governor of Reserve Bank of India shortly .

Also PSBs face a major dilemma of whether to accept business that is being rejected by private and foreign banks as the latter fears any exposure would add to the rising non-performing assets in the system. Confirming the NPA scenario, Roopa Kudva, managing director and CEO, Crisil, apprehended that the absolute quantum of NPAs would go up three times from the current NPA level to Rs 2 lakh crore by the year 2011.

Currently, the total credit of the Indian banking system is Rs 27 lakh crore. Crisil is projecting the maximum increase in NPAs to come from the corporate sector, she said.

Today, liquidity in the system is ample. However, bankers are adopting a cautious approach now-a-days while lending to the corporates as they are concerned very much about their future non-performing assets, Kudva added.

However, the fact remains that Indian Inc currently depends upon on public sector banks solely to meet its funding obligations. All other sources of funding for corporates till few weeks ago had been completely shutdown, she pointed out.

Chakrabarty further explained, “There is always pressure on net interest margin (NIM) for banks like ours. Still, I am targeting to maintain it at the level of 3.5% during the current fiscal. There may be some pressure on NIM during the first quarter, but I will be able to cope up with it by adjusting my rates during the second quarter onwards. See, there is no change in the interest rates on saving deposits which comprise 35% of my bank’s total deposits and we don’t have to pay anything on the current account. The remaining deposits are only incremental rates of which are decided by the ALCO. So, going forward, I hope I will be able to tackle the NIM.”

MV Nair, CMD, Union Bank of India, said that there may be some pressure on the bank’s NIM during the first quarter of the current fiscal due to the deposits that were contracted at higher rates a year ago. But he was hopeful that it would improve from the second quarter onwards. “Still, I think that my bank will be able to maintain its NIM at the level as it was on March 31, 2009 of 2.85% during the current fiscal too,” added Nair.

Giving examples, Nair said that year-on-year deposit growth during the period was 35% while loan growth was at 27%. The question is what to do with the surplus money. “The alternate avenues gave an average return of close to 5%,” he said. If the bank invests the surplus money in reverse repo, it would get 3.25%, and any in G-sec investment is pegged at 6.50%, said Nair. Also the launching of the special home loan schemes (frozen at 8% for the first one year)by the public sector banks will put pressure on their s net interest margin. For 2009-10, the bank has a deposit growth target of 23% and advances growth target of 25%.

Explaining the paradox of the public sector banks, Ananda Bhowmik, director, Fitch Ratings, said that the net interest margins of banks in India are likely to come under marginal pressure in the present financial year.

In the current as well as the next quarter of this fiscal, there exists a strong possibility of further cuts in the prime lending rates of banks in a bid to stimulate their credit-offtake.

Soumendra K Dash, chief economist, CARE, said that the recent reduction in deposit rates by the banks would lower their cost of funds over a period a time and not immediately. The cost of deposits has a larger bearing over the cost of funds as deposit constitutes larger proportion of the total fund of the bank. “Also, there is pressure by the regulator on banks to lower their lending rates. It would thus lead to a squeeze in the net interest margins of the banks especially in the current quarter,” said Dash.

A senior executive of Central Bank of India, who preferred to remain anonymous, added that when deposit rates offered by Indian banks were attractive in the last few months, people might have locked-in their funds for a longer tenure.

Thus, the cost of funds for the Indian banking space is yet not low, in spite of the recent cuts in bank deposit rates. Also, the regulator is signaling the banks to further lower their lending rates. It’s therefore going to affect the net interest margin of the Indian banking space in the current year.

However, Kudva observed that enough availability of money was yet not there for mid-rung as well as smaller companies in India. “Cost of funds still continues to be an issue although now we are beginning to see the effect of the rate cuts that happened six months ago. The issue in India is that monetary transmission is not as strong as it can be. And hence the lag effect of the previous rate cut being witnessed,” she said.

So, the question is: Can the Indian banking system sustain even with 15%-16% credit growth ? Is it enough to drive our 6% GDP growth?

The upturn in lending will be lead by state-owned and not private or foreign banks in India. NBFCs and mutual funds too are shrinking as far as funding options are concerned. With banks today concerned about their asset qualities and also have a sharp eye on their bottom-lines. Will l the PSBs bite the bullet?

?(with inputs from Kumud Das & Hemang Palan)