Banking in FY20: Getting the CAMEL back on its feet

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Published: May 6, 2019 5:02:24 AM

Capital is the driving force in banking, more pertinent for PSBs. This issue has to be tackled head-on in the current year as the demand for credit should be better since there would be no disruptive policy.

Banking in FY20, CAMEL, capital adequacy, asset quality, management, earnings, liquidity, financial express, opinionBanking in FY20: Getting the CAMEL back on its feet

Every year throws up new challenges for the banking sector, and FY20 will be no different. The Q4 results of some banks are out and there are signs that the NPA recognition process may not yet be over. In the past, it was always said that whenever there is a change of guard in public sector banks, there are accelerated revelations on the quality of assets that tend to depress the earnings picture. It is now happening for private banks, too, and, hence, we may have to wait and see how things transpire during the course of the year. Against this background, the five pillars of banking that come under the now conventional CAMEL framework may be debated.

Capital is the driving force in banking, more pertinent for PSBs. This issue has to be tackled head-on in the current year as the demand for credit should be better since there would be no disruptive policy. While overall growth projections for the economy are not very different from that in FY19, credit growth, even if maintained at the existing level, would call for more capital from banks. In FY18, incremental capital plus reserves, which forms the core of capital for calculating capital adequacy, was around Rs 85,000 crore. Of this, only Rs 10,000 crore came from PSBs. If bank credit grows by 13% in FY20, which is the same as in FY19, then to maintain a cumulative CAR of 9%, an additional Rs 1.15 lakh crore would be required. This has to come from either retained profits being ploughed back or fresh capital infusion.

The former looks possible only in case banks are able to make profits, which implies that there should be no additional provisioning for bad assets due to the recognition syndrome of the asset quality review process. While it was generally believed that the worst was over in terms of legacy NPAs, it needs to be seen if more banks have any such recognition when the Q4 results are announced. The latter throws the ball back in the government’s court as weak PSBs need to be recapitalised further in case there is paucity of the same as of March 2019. The Budget has not made any provision for such recapitalisation that has to be provided in case the need arises. This can be included in the formal Budget in June/July. As some of the prompt and corrective action (PCA) banks will be coming out of the net gradually, the capital issue would have to be addressed with some urgency.

There are talks of some more PSB mergers, which may not actually add to capital of the system, though some of the weaker merged banks may look better. There has, however, not been any mention of divestment, which is understandable as given the present state of banks, the valuation will not be satisfactory.

Asset quality is the other issue of interest. Have all the past NPAs been recognised? If so, have provisions been made? This will have a bearing on the P&L accounts of banks. The other important development will be the way in which banks tackle the resolution process. The Supreme Court judgment on the RBI circular of February 12 does not make the one-day default rule lead to the 90-days resolution channel that subsequently takes the asset to the IBC. It, however, does not stop banks from still taking such action. If the onus is on the banks, the question is whether or not they would look at a solution or prefer to kick the can as was done even earlier before the IBC came in. This will be a call that has to be taken by the banks. Banks, as a rule, have an incentive to keep the asset away from the IBC and defer a resolution as it would mean taking a haircut. At the same time, there is also pressure to show stronger balance sheets. Hence, there can be an incentive to procrastinate on such resolution.

Management is the third part of the banking outlook for FY20. A lot has been said on this as it raises issues on governance. This, now, holds for both public and private sector banks. RBI had a discussion paper on compensation for senior bank officials and brought in the issue of claw-back for the first time. Therefore, the way managements conduct business and are held responsible for performance will be something to be watched carefully. Also, the efficacy of the Banks Board Bureau would be tested as decisions are taken on the composition of Boards as well as CEOs. FY18 and FY19 have been particularly challenging for some banks from the point of view of governance, and it is necessary to have the house in order for ensuring a safe future of the system. There are lessons to be learnt from the past and systems have to be made foolproof given that banks are the fulcrum of the financial system.

Earnings will come back to the forefront, provided that capital and asset quality issues have been addressed. Here, banks have to work around with enhancing efficiency so as to improve their operating profits in a scenario where interest rates are likely to decline rather than increase. RBI has indicated an accommodative stance and banks have to follow up with appropriate action to enhance business. The important thing is to balance credit risk with enhanced business levels. Banks have been holding on to excessive SLR paper, which was a safe haven. Some change will be called for as commercial credit demand increases. Risk evaluation has to be at the top of the mind to ensure that growth in new incremental NPAs is contained.

The last part of the approach is liquidity and its prospects for the year. Unlike FY19, liquidity would be less of a challenge as growth in deposits is expected to be higher this year. The recent spate of disruptions in the mutual funds market, especially in the debt segment, will mean a reverse migration to the ‘safer and lower returns’ haven of bank deposits. This would be beneficial for banks which had to contend with sluggish growth in FY19. To the extent that RBI would be there to provide liquidity through both OMOs and LAF, it would be comforting for banks.

In a declining interest rate scenario, the sixth element of ‘sensitivity to market risk’ would be less of a concern as securities get valued at higher prices which will help the P&L. The risk on forex would be there to an extent but as the rupee is not expected to depreciate by more than 3-4% which is the trend, there would be less pressure on banks as well as corporates who otherwise do run a high currency risk on imports and debt.

Hence, FY20 will be a crucial year for banks as the true picture on the internals would be revealed. The challenge would be to get back from the abyss and move ahead in a meaningful manner so as to take the banks back to a robust, well-capitalised system with a cleaner asset portfolio and governance in place.

Chief economist, CARE Ratings. Views are personal.

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