Banking woes threaten India’s improving cyclicals

By: and |
Published: July 23, 2018 3:00 AM

The original recapitalisation plan involved raising of equity by banks to the tune of Rs 0.58 trillion, which has become uncertain following the subdued investor sentiment with respect to PSBs. It leaves the government with difficult options to restore the lending capability of PSBs—one of which could be further recapitalisation.

The Indian economy is showing signs of rebounding from the twin hiccups of demonetisation and the implementation of the goods and services tax (GST). Investment data in terms of gross fixed capital formation (GFCF) and the Index of Industrial Production (IIP) capital goods is showing signs of revival, even as the project investment activity appears to be lagging behind. In the given scenario, the pertinent question is: If the credit demand in the economy gathers steam as growth improves, are banks equipped to handle the higher demand or will the current woes in the banking sector disturb India’s improving cyclicals?

Banks’ non-food credit growth has improved to above 12%—from a low of 4-5% in the beginning of 2017. So far, the growth in credit is mainly led by the services sector and the retail loan category—both recording year-on-year growth of around 20%. The credit demand by the manufacturing sector is still growing by a minuscule 1%. Not to forget the non-banking financial company (NBFC) sector that has taken away some share from the banking sector and has been recording a strong growth in their loan book. Going forward, the credit demand from banks could increase as economic growth gathers momentum. The need for working capital from the manufacturing sector could also go up, considering the firm trend in commodity prices lately.

It is interesting to note that private sector banks have had a disproportionately higher share in whatever pick-up in bank credit that we have seen in the last couple of years. Public sector banks (PSBs), which have historically had a share of around 70% in the outstanding bank credit, are seeing their share reducing in the last few years. Private sector banks had a share of 65% in the incremental credit growth in the last two years (March 2016 to March 2018), while the share of PSBs was only 29%. Weak growth in lending by PSBs reflects the overhang of non-performing assets (NPAs), as also the constrained capital base for some of them. In fact, 11 of the PSBs (accounting for 18% of the market share) are under RBI’s PCA (Prompt Corrective Action), restricting their lending further.

On the other hand, PSBs continue to attract a fairly larger portion of the deposits, although they are losing market share to private sector banks on this front, too. In fact, over the last two years, PSBs accounted for nearly half of the incremental deposits, a shade higher than private sector banks. Consequently, one sees a divergent picture in the credit-deposit ratio between public and private sector banks.

For the banking sector as a whole, the credit-deposit ratio stood at 76% in March 2018, while for private sector banks as a whole, it has risen to a high of 88%—with close to 100% for some of them. Of the total bank deposits, around 20% needs to go for statutory liquidity ratio (SLR) commitment—which implies investment in government bonds—and 4% for CRR (cash reserve ratio, to be maintained with RBI). This leaves only around 75% of the deposit for lending. Private sector banks have been sustaining higher credit-deposit ratios so far with the help of borrowings, including raising of funds in the overseas markets. As the tide of the global liquidity is gradually turning, there may be limitations in the future on private sector banks’ ability to accommodate the credit demand. Further, many private sector banks have been showing a strong preference for retail lending.All of these imply that higher lending by PSBs will be imperative if the credit demand from the corporates grows and if the investment cycle turns up.

The government has been alive to the problem. The two actions taken last year—of pushing large NPAs into the Insolvency and Bankruptcy Code (IBC) process and the announcement of a massive Rs 2.11 trillion recapitalisation plan—were meant to help PSBs ‘clear the past’ and grow their lending operations once again. However, the actions have proved to be inadequate, so far.

The resolution of NPAs through the IBC process has been painfully slow—with several legal challenges slowing the process. Moreover, bottom-up estimates by some analysts suggest that the extent of haircuts that banks will need to undertake in the cases that are still to be resolved could be higher, at around 60%. Further, RBI has discontinued the erstwhile restructuring schemes for stressed assets and has now stipulated more stringent time-lines for the resolution of stressed assets, failing which the assets need to be compulsorily referred to the IBC process. These stipulations may lead to recognition of more NPAs (especially in the power sector) and more IBC cases where haircuts could be even larger.

The ‘Sashakt’ scheme—which aims at resolving the problem of NPAs through a market-led approach—is now seeking to create a layer of coordinated efforts, involving a new set of investors in stressed assets, before such assets are taken to the IBC. However, the efficacy of this new initiative is unproven, as yet.

Meanwhile, the increase in NPAs during the last quarter of FY18 and the losses booked by banks on their investment portfolio after the sharp jump in bond yields have already caused massive losses (over Rs 0.8 trillion in FY18) for PSBs. This eats away a significant chunk of the recapitalisation efforts that are under way. The original recapitalisation plan involved raising of equity by banks to the tune of Rs 0.58 trillion, which has become uncertain following the subdued investor sentiment with respect to PSBs. It leaves the government with difficult options to restore the lending capability of PSBs—one of which could be further recapitalisation. Recap bonds have been essentially a way of breaking a large burden of today into many small parcels and distributing them into several years into the future. More of that strategy may become imperative if the ‘Sashakt’ scheme does not fulfil its stated promise.

Mangesh Soman & Rajani Sinha 
(Authors are corporate economists based in Mumbai)

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