Up But Not Yet Running

Updated: Oct 20 2002, 05:30am hrs
The banking industry is grappling with the problem of plenty. While the bourses witnessed a bloodbath and yield curves of debt products moved southwards, the small investors lined up to banks to park their money.

Banks flush with liquidity are finding it hard to generate returns adequate to service the deposits. Credit offtake is minimal as the economy is still in shambles. The banks are forced to lend at sub-prime lending rates (PLR) (the benchmark lending rate of banks for triple-A rated corporates). As a result, the spreads are getting squeezed which is denting the bottomline.

The age-old problem of high level of non-performing assets (NPAs) is still bogging down most of the public sector banks. In many cases, the percentage of net NPA to net advances is as high as 6.5 per cent and gross NPA to gross advances at 12.5 per cent, as per the RBI data for fiscal 2002 and estimates by Fitch Ratings India. This is even after the banks resorted to higher provisioning for bad loans and putting emphasis on recoveries last year. The government had established Debt Recovery Tribunals to push through one-time settlement of bad loans, but the results have not been very encouraging so far.

The first-quarter results have, in fact, disappointed the market with the banking stocks taking a dive since July. The fund managers and market experts, however, see an opportunity in the decline in banking stocks. They see the huge growth potential due to rapid urbanisation, changing demographics in favour of the youth, changing mindsets leading to greater acceptance of technology and the low retail loan to gross domestic product ratio. Besides, consolidation activity in the industry may also drive up banking stocks.

The returns in these stocks during the half-year period ended September 30, 2002, range between 50 per cent for stocks like Andhra Bank, Dena Bank and Karur Vysya Bank to a negative 42 per cent in Global Trust Bank, Centurion Bank and Federal Bank.

Industry Overview
Fitch Ratings India recently did a study of 24 public sector banks which revealed that fresh NPAs of Rs 111.8 billion were added in fiscal 2002 while they were able to reduce only Rs 88.1 billion through cash recoveries, write-offs and upgradation of accounts during the year.

In addition, high operating costs due to inefficient systems and heavy employee costs, especially in the public sector banks (PSBs), have drained resources. While the growth in demand for credit is poor, all these factors coupled with stiff competition are putting pressure on the spreads. Private sector banks, on the other hand, have also been forced to increase the number of employees to service the expanding retail business, increasing employee costs.

The major threat for the Indian PSBs is from the smaller, newer and more dynamic private sector banks and also foreign banks. Though the old PSBs are large, due to their inefficiencies they are unable to compete. PSBs have also been fast losing market share to private players. The PSBs may appear big in India, but their size is small when pitted against global counterparts. According to a recent report from Kotak Securities Investment Research, The largest bank in the country, State Bank of India, has an asset size of $71 billion compared to the $524 billion asset size of the largest Chinese bank. The report cites regulatory restriction of foreign investment (limit of 49 per cent) and a cap on voting rights (at 10 per cent) as factors that have made acquisitions in the Indian banking sector less attractive.

Most public and private banking companies have utilised the windfall gains in fiscal 2002 to improve their asset quality by resorting to higher provisioning for NPAs. PSBs have also reduced the workforce through attractive voluntary retirement schemes improving their bottomlines.

Competition has also forced them to emphasise on technological upgradation and quality of service. They are striving hard to extend their delivery channels through ATM network, phone and internet banking facilities. Following the newer banks in the private sector, PSBs are focussing on low-cost high-return fee-based activities, consumer and housing loans, credit cards, debit cards, etc.

The private sector banks first discovered the opportunity in the retail segment and cashed in on it. The report by Kotak Securities highlighted a recent speech by HDFC Bank managing director Aditya Puri pointing out: The relative small share of retail deposits held by private players (12 per cent), low geographic penetration levels, and low penetration level of retail products (example: loan to GDP ratio at 2.6 per cent) including mutual funds and insurance products provide tremendous opportunity to private players for retail banking in the country. The large 15-24 years age-group population, changing mindsets, higher acceptance of technology and increase in urbanisation are a few of the key factors driving growth for consumer products."

Looking at the long-term benefits, many mutual funds have increased their exposure to banking stocks. A recent survey on Indian domestic fund managers by Merrill Lynch shows that more fund managers were overweight on the banking and finance sectors, after pharma and IT.

According to IDBI Principal AMC chief investment officer (CIO) Rajat Jain, We believe that banking, as a sector, is tremendously undervalued. The fundamentals are improving. The PSBs have become more technology savvy which is leading to efficiencies in operations and reducing costs. The retail market growth can still continue. Besides, the NPAs are going to be under control as banks are more careful about their credit decisions and the securitisation ordinance should help them recover a part of their overdues. The banking sector is, thus, poised to gain on a turnaround in the economy.

According to IDBI Principal AMC managing director and chief executive officer Sanjay Sachdev, The banking industry is poised for a major growth in the coming years. The deposits have been growing at a robust pace over the years. Besides, the Reserve Bank of India allowing two more companies, Kotak and Rabo, to set up banking operations shows that there is still scope for more players in the industry.

The Performance
Financial results in the first quarter of the current fiscal were largely disappointing compared to the previous quarter with the aggregate operating profits of 35 listed private and public sector banks slipping by 14.27 per cent to Rs 5,270.38 crore as against Rs 6,147.35 crore in the quarter ended March 2002, according to Asian CERC data. The decline has been sharper in the 21 listed private banks which saw aggregate operating profits slide by over 29 per cent to Rs 1,188.81 crore (Rs 1,670.78 crore). Interest cost of these private sector banks has increased to Rs 4,654 crore (Rs 3,530 crore) during the quarter. However, public sector banks saw the interest cost decline to Rs 11,695 crore (Rs 12,244 crore).

Aggregate operating incomes of the 35 banks also declined marginally with the set of 14 listed public sector banks contributing the most to the slide. However, a sharp cut in provisioning allowed these banks to post a higher net profit compared to the previous quarter. Aggregate net profits of the 35 banks surged 26 per cent from Rs 2,081.91 crore in quarter ended March 2002 to Rs 2,623.34 crore in quarter ended June 2002.

Nevertheless, experts feel that a weak monsoon during the current year is expected to hit the banks. Way2wealth vice-president, business development, Arun Kumar Gupta says: Credit offtake in the rural segment would be adversely affected due to the failure of the monsoon and will show on their bottomlines in the coming quarters. However, Mr Jain differs: We do not think that the impact of the drought has been significant. We expect that the recovery rates for banks in the rural areas will not be very significantly different from what they have historically been in the past. However, to the extent a slowdown in the rural economy has an impact on the industrial recovery, we would expect the retail thrust from the PSBs to continue.

The merger and acquisition activity in the industry also made the banking stocks gyrate to developments. Stock markets were agog with the news of ICICI merging with ICICI Bank, ING picking up stake in Vysya Bank, Punjab National Bank acquiring Nedungadi Bank and frequent rumours of acquisition of Centurion Bank.

The second quarter is not expected to bring any respite and some of the larger PSBs will have to cope with the cap on lending in the call money market as per the monetary and credit policy 2002-03. The policy spells out that the banks are not allowed to lend more than 25 per cent of the owned funds in the call money market.

Mr Jain says, The limit on lending in call money market for banks only came into effect in October. There was, hence, no effect of this policy change on profits of banks for the half year ended September. Mr Gupta agrees: With the cap on lending in the call money market, banks have been shifting their investments to the debt funds and foreign exchange forwards.

ICICI Bank has been in the news recently due to the merger with its parent ICICI, creating the largest private sector banking company in India. However, the stock markets gave a thumbs down to the consolidation activity as ICICI brought its high NPAs into the merged entity. Besides, the profit margins are expected to be hit due to inefficiency of the parent post merger.

However, industry experts maintain that the move may prove beneficial in the long term. The bank will get a size advantage and be better equipped to withstand competition from much larger foreign banks. In fact, the international credit rating agency, Moodys Investor Service, has upgraded the long-term foreign currency rating of ICICI Ltd from Ba2, the sovereign rating for India, to Ba1, which is one notch higher than Indias sovereign rating.

But the first quarter financials already indicate the effect. While the operating income of the merged entity ballooned five times in the quarter ended June 2002 as against the same quarter last year, the operating profits have increased by a mere 2.39 times and earnings per share by 1.39 times. As a result, the operating profit margins plummeted from 20.23 per cent in the quarter ended March 2002 to 13.82 per cent in quarter ended June 2002. In order to shore up net profit margins, the bank has cut down on its provisioning to Rs 49.46 crore as against Rs 138.07 crore in the preceding quarter.

State Bank Of India
The bank has the advantage of scale, well-spread branch network and huge consumer base. It has been focussing on reducing the level of non-performing assets and number of employees, enhancing use of technology, branch networking, new products, internet and phone banking. SBI has been able to reduce the employee cost to operating cost ratio to 75.93 per cent from 76.13 per cent in the fiscal 2001 and improve the investment to deposit ratio from 0.51 times to 0.54 times during the period.

However, the quarter ended June 2002 saw operating income, other income and operating profits decline as against the preceding quarter. On the other side, employee and other expenses and interest liability declined. The bank also reduced the provisioning which saw the net profits increase to Rs 763.2 crore in quarter ended June 2002 from Rs 615.69 crore in quarter ended March 2002.