»5 Minute Wrap Up by Equitymaster

On This Day - 18 MAY 2017
Why We Skipped This 70% Gainer

In this issue
» Debt ridden Telecom Sector faces RBI music
» The Dangerous Politics of Loan Waivers
» Market Update
» And more...

00:00 Chart of the Day

Madhu Gupta, Research analyst

During the financial crisis in 2008, when global financial behemoths were falling like a pack of cards, Indian banks were unscathed.

Their strong and conservative credit systems were greatly lauded at that time.

However, a few years down the line, they seemed to have lost the plot completely.

As the economic downturn gripped the country, not only did credit growth slow to multi-decade lows but souring loans that were extended to India Inc started to push banks down a deep chasm.

The state-run banks were the first to step onto the firing line. After the RBI's mandatory asset quality review in the latter half of 2015, public sector banks hamstrung with inefficiency and bureaucracy quickly fell to the mounting corporate bad loans.

India Inc in the Centre of the Bad Loan Storm

On the other hand, private sector banks were in a much better position. Not only were their retail-focused operations witnessing robust credit growth, but even the loan defaults weren't too significant.

By the end of March 2016, the gross bad loans of public sector banks had shot up to 10%. At private banks, they increased marginally to 3%.

During the spiraling bad loan crisis, private banks were largely seen as safer than their troubled public sector counterparts.

The perceived safety of some of these private sector banks has turned out to be a mirage, an illusion of water created by burning sands in deserts.

This became amply clear after a recent RBI notification mandated banks to report diversion in their reported and audited NPA numbers (varied more than 15%).

Turns out Yes Bank was the most errant bank.

It reported a gross bad loan ratio of 0.76% for FY16, much lower than the 5% as per the RBI audit.

Meanwhile, the stock gained more than 70% in the twelve months of FY17.

Yes Bank defended its action claiming remedial measures have reduced the divergence in FY17.

But the fact of the matter is that Yes Bank underreported its bad loans.

Reportedly, other private sector banks also kept their bad loans under wraps.

The question now is how much can we trust these banks? They failed to be fair and transparent in disclosing bad loans, which are an important metric to judge their risk preparedness and ultimately their earnings capability.

All this while, markets were giving state-run banks the short end of the stick as most of them were left with bloated bad loans after their asset review in 2015.

However, private sector banks continued to enjoy the market's goodwill by keeping bad loans to the minimum despite registering robust growth.

Clearly, banking on the clean image of private banks had its pitfalls. The stock of Yes Bank has corrected just 10% from its peak after its actual bad loans came to light. But lack of transparency could go a long way in hurting the credibility and valuations of select private sector banks.

At Equitymaster, we never get carried away by the favourable dynamics of a sector. Rather, we've always followed a rigorous bottom-up approach to stock picking.

Even at the height of the bad loan crisis, we steered clear of private sector banks that were growing recklessly. After conservatively weighing risk management capability, only a few private sector banks made the cut for our large-cap recommendation service Stockselect.

In hindsight, it's easy to identify a mirage. But in the heat of the desert, only a seasoned eye can discern the deception. A bottom-up strategy is the only shield against wealth-destroying mirages.

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Talking about bad loans, Indian banks are struggling with non-performing assets (NPAs) for quite some time. Stressed assets have been consistently rising over the last few years. New addition to this list is the telecom sector. Last month, the Reserve Bank of India (RBI) advised to set aside higher provisioning for the telecom sector starting from the first quarter of FY18. As per the RBI's notification, interest coverage ratio for the sector is less than one. A ratio of less than one indicates that companies are not able to service their full interest from the operating profit, a clear sign of high stress.

The telecom industry had outstanding debts of nearly Rs 4 lakh crore, incurred mainly on the back of payments for spectrum, spectrum usage charges and other levies. With the entry of Reliance Jio, the industry has been going through a turbulent period.

Take the recent results of Bharti Airtel, Idea Cellular, and Vodafone India. In the case of Airtel, profit was down 82%. Idea registered a loss of Rs 4.26 billion. Vodafone India reported a 10.2% decline in operating profit. The telecom industry is now on a downward trajectory as far as margins and profitability are concerned.

Don't be surprised if the banks refuse to lend more to the sector going forward.


As per the recent report on State Finances 2016-17, RBI warned that loan waivers could have an adverse bearing on the fiscal viability of states. The report reasons that loan waivers impact credit discipline, vitiate credit culture and disincentivise borrowers from repayment.

To fund loan waivers, various state governments need to issue debt relief bonds. With this, overall government borrowing would increase. This will have an impact on yields. Yields on state development loans (SDL) may firm up posing a higher interest burden in the future.

Our big picture expert Vivek Kaul explains it succinctly in his Diary:

  • The decision of the Uttar Pradesh to waive off loans, is likely to lead to a similar demand and decisions from other states. Such demands have already been made in Maharashtra. They may soon be made in other states where elections are due in the months to come. And this is something which isn't good for the nation as a whole.

    If several state governments raise money in a quick time, it can push up interest rates as well, despite the fact that currently the demand for bank loans is low. It will also push up the combined fiscal deficit of the state governments and the central government, which as I said earlier in the piece, is already high.

Vivek Kaul has written some brilliant articles on this topic. Read it here. I highly recommend it.


After opening the day on a negative note, Indian share markets witnessed further losses and continued to trade in the red. At the time of writing, BSE Sensex was trading lower by 100 points and NSE-Nifty was trading lower by 39 points. The mid cap index is trading down by 0.45%, while the small cap index is trading down by 0.42%.

04:56 Investment mantra of the day

"Valuing a business is part art and part science." - Warren Buffett

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