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BW Businessworld

Resurgence, Resilience And Resolve

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For the banking industry, FY12 has been a year of attrition. from October 2011, policy interest rates have been raised in relatively quick succession by the Reserve Bank of India (RBI), even as the economy slowed from the high GDP growth rates in FY09 and FY10. The impact on bank balance sheets has been to compress net interest margins (NIM) — the difference between average cost of deposits and interest income on bank credit.

It is fairly well established that growth in banks’ balance sheets has slowed, both on the assets (loans) and liabilities (deposits) fronts. Credit growth declined to 18.1 per cent in FY12 from nearly 23 per cent in FY11. Similarly, deposits grew by close to 15 per cent, compared to more than 18 per cent in the previous year.

The flight to safety and risk aversion was evident from the increased attraction for government securities, which grew by nearly 20 per cent in FY12, compared to just 6.6 per cent in FY11. Blame the weakening macroeconomic outlook and rising non-performing loans, or NPLs.

In FY12, the trade-off between growth and earnings came to a head. In the two previous years, banks were willing to settle for lower NIMs but faster growing balance sheets. In 2012, the trend began to move in the opposite direction. Part of the explanation is in the spike in NPLs.

“For one thing, banks had to go in for a system-based marking of NPLs, implying there was little discretion for managements to recognise problem loans, and recognition norms were applied strictly,” says A.S.V. Krishnan, banking senior analyst with Ambit Capital, a Mumbai-based firm.

But as the annual RBI report, Trends and Progress of Banking in India, showed, asset quality suffered: gross NPLs as a percentage of gross advances went up to 3.1 per cent compared to 2.5 per cent in FY11. The amount of loans that went into corporate debt restructuring went up dramatically, to marginally over 5 per cent from less than 4 per cent in FY11.

Efficiency ratios improved slightly: the cost to income ratio actually improved, though NIMs declined marginally. In these circumstances, banks were forced to review growth strategies and opt for greater prudence. How did this affect the banks in the universe of Businessworld’s Best Banks Survey 2012?

Through good times and bad, class will tell. A look at the shortlist of banks eligible for the best banks’ awards shows the same names across all categories. Almost all winners have won awards in the previous editions of this year’s survey, some of them being repeat winners in a category (Karur Vysya Bank in the small banks category for three years running). HDFC Bank, after a gap of two years in which ICICI Bank won the most tech-friendly bank award, returned to the winner’s circle this year.

Last year, about two-thirds of the banks that make up the universe of the study sent in responses to the risk survey. This year, the number of responses was lower. Even accounting for logistical problems, we had hoped to get more responses. Perhaps the changes in the environment led banks to take a closer look at risk management; next year, we hope the level of responses will go up again.

The past has been a prologue of sorts when one looks at the last two quarters. With changes in the business environment over the last two years, the fastest growing banks were assessed by incorporating an asset quality metric. The results of the deterioration in FY12 are beginning to show up now. “There were positive surprises among private banks on earnings and asset quality, demonstrating better credit-pricing skills,” says Nick Paulson Ellis, country head, strategy and special situations at Espirito Santo Securities, an independent research firm. Public sector banks, on the other hand, showed volatility in earnings and inconsistent asset quality. The rankings presage that to some degree.

What will things look like in the next edition of the survey? Asset quality may take a further beating in this financial year. The analysis suggests that a lot of the NPLs in the cyclical and non-infrastructure businesses may not have been recognised as yet.

“There is a two successive quarter lag before they start showing up,” says another senior banking analyst from a securities firm. “In the next six months, NPLs could spike a little more.” But private banks — and some public sector banks — may have been a little aggressive in recognising them in the first two quarters of FY13, and that will stand them in good stead. There are a number of regulatory changes that banks are preparing for; to be fair, many of them have been preparing for them for some time. Basel III norms are one example, though the move towards them could prove challenging for some banks in our universe.

The macroeconomic outlook — both global and domestic — does not look too rosy either. So banks may well have to revise the way they do business. Large banks, for instance, are used to taking big exposures up front, and then sell them down to smaller banks eager to get a piece of the action so they do not miss the economic growth play. Now, transferring risks after origination may not be that easy in the coming six months.

Yet, many banks — Bank of Baroda comes to mind — have built steady and prudent practices that others may have to emulate in building strong portfolios in the retail and small and medium enterprise segments, for instance. Despite the challenges and gloomy outlook, one feature stands out in this year’s exercise: resilience. While banks have had to deal with substantial increases in NPLs and the accompanying provisioning, they have been able to weather the times better than expected. Things could well get worse before they get better, but resilience stays.


(This story was published in Businessworld Issue Dated 26-11-2012)