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Budget 2011: Banking

In the current fiscal (FY11), the Indian Banking industry has had to deal with tight monetary policy and low liquidity. This is despite the economy expected to grow at a healthy pace of 8.6% this fiscal. The central bank raised interest rates 7 times, cumulatively increasing the repo rate (rate at which banks borrow from the RBI) by 1.75% and the reverse repo rate (rate at which RBI borrows from banks) by 2.25%. However, with inflation still off RBI's target 7% for the end of FY11, further rate hikes are still expected.

Liquidity still remains a major concern, with the level of tightness currently beyond RBI's comfort level. The widening gap between credit and deposit growth was one of the major reasons for the same. Credit growth in the country has been rapid with non-food credit growing at 24.4% as per December 2010 data. This is against a projection of 20%, showing a huge demand for funds in one the world's fastest growing economies. However, deposit growth has lagged growing only by 16.5%, against a projection of 17%, leading to an unsustainable liquidity situation.

 Budget Expectations
  • Clarification of stance with respect to issuing new back licenses, especially to NBFCs and industrial houses.

  • Tax benefits on long-term infrastructure bond investments could be extended till FY12. Banks are expecting to also be given this window for fund raising. Previous budget allowed an additional Rs 20,000 deduction for investment such bonds; this limit may also see a hike.

  • Higher exposure limits for banks to finance UMPPs (ultra mega power projects) and other power projects.

  • Liquidity concerns need to be addressed as the situation has not completely eased yet.

  • Further recapitalization of certain PSU banks

  • Currently, rules limit voting rights of foreign entities to 10% irrespective of the actual stake they hold. Bankers expect the government to remove this clause, allowing additional capital to flow into the sector.

  • Financial inclusion needs to be addressed - incentives/subsidies need to be provided for banks to set up accounts/ branches in Indian villages as these have low transaction volumes and high servicing costs. More clarity on Microfinance Institutions (MFIs) also expected.

  • The Government set up a Financial Stability and Development Council (FSDC), a regulatory body to oversee issues related to regulation, financial inclusion, and financial stability during the last budget. More clarity on the working of the same is needed.

     Budget Measures
  • The RBI will be issuing guidelines on additional banking licenses before the close of the current financial year.

  • An sum of Rs 60 bn will be offered to under-capitalized public sector banks to ensure that all PSU banks are able to attain a minimum 8% Tier-I capital ratio by FY12.

  • In order to step up agricultural credit the target for bank credit has been increased by Rs 1,000 bn to Rs 4,750 bn for FY12. Banks have been asked to increase focus on credit lending to small and marginal farmers.

  • From the current market interest rate of 7% for crop loans, a 3% interest subvention (2% previously) has been given to farmers who pay their dues on time. This effectively leads to a low interest rate of 4% on crop loans.

  • In order to promote regulation of microfinance institutions (MFIs) the government is considering putting a regulatory framework in place in order to protect small borrower interests. Rs 1 bn 'India Microfinance Equity Fund' is to be created with SIDBI to help smaller MFI's maintain growth and achieve reasonable scale and efficient operations.

  • Under the financial inclusion target, banking facilities will be provided to all 73,000 habitations having a population of over 2,000 during FY12. This year (FY11), 20,000 villages will be covered.

  • In order to help route banking funds into the rural infrastructure, the corpus of the Rural Infrastructure Development Fund (RIDF) XVII is to be raised to Rs 180 bn in FY12 from Rs 160 bn currently.

  • IIFCL which refinances bank lending to infrastructure projects will enhance its disbursements Rs 200 bn in FY11 to Rs 250 bn by FY12.

  • Additional deduction of Rs 20,000 for investment in long-term infrastructure bonds is proposed to be extended for one more year.

  • In order to attract foreign funds to financing infrastructure in India, special vehicles in the form of notified infrastructure debt funds are to be created. Interest payment on the borrowings of these funds will now be subject to a reduced withholding tax rate of 5% instead of 20% currently, and the income of the fund will be tax-exempt.

  • Scheme of 1% interest subvention on housing loan extended for homes upto Rs 1.5 m (from 1 m previously), where the cost of the house does not exceed Rs 2.5 m (Rs 2 m previously).

     Budget Impact
  • Recapitalisation of PSU banks will mean that the under-capitalised banks do not fall short of capital to grow their loan book and at the same time are able to comply with Basel III norms.

  • Clarity on sanctioning additional banking licenses could pave the way for participation of foreign banks and NBFCs in the financial inclusion motive.

  • Higher target for agricultural credit and may lead to some NPA problems in this sector. However the incentives for timely repayment of loans with lower interest rates will help offset the same.

  • Discounted interest rates on low cost housing and increased limit for priority sector lending in urban areas will be beneficial for banks and housing finance companies. Mortgage Risk Guarantee and the Rural Housing Fund will also help financing companies increase their presence in smaller cities and villages.

  • Clarity on microfinance regulatory framework and funds to promote smaller MFIs and self help groups will help increase growth in this industry, and help promote financial inclusion. However, there is a huge target for banking facilities to be added in rural areas. This may lead to additional costs for the banks, as creating facilities such as these have not been incentivised.

  • Infrastructure financing companies are set to benefit from the higher allocation, extension of fiscal benefits for infrastructure bonds in addition to foreign investor participation in infrastructure financing.

     Company Impact
  • Banks like OBC, UCO Bank, Corporation Bank, Andhra Bank that currently stand undercapitalized will receive additional capital under the PSU banks' recapitalization scheme.

  • Various entities including Shriram Transport Finance, IndiaBulls, Religare, IL&FS, IDFC, IFCI , PFC, REC and some industrial houses, were all looking at entering the banking space. With the RBI expected to dole out licenses in by the end of the fiscal, some of these entities will be huge beneficiaries.

  • Microfinance intuitions like SKS Microfinance will benefit from regulatory clarity, however this will also lead to more competition in the space.

  • Housing finance companies like HDFC and LIC Housing Finance, Dewan Housing Finance as well as PSU banks like SBI, PNB and Union Bank of India that have extended presence in the semi urban and rural areas will benefit from the interest sops offered to loan on low cost housing.

  • Extension of fiscal benefits on long-term infrastructure bonds will be beneficial for companies like REC, IDFC, PFC, L&T Finance, as they can access cheap domestic funds. They have already been in the market this year, so raising new funds next year should not be an issue.

    Budget Impact: Banking Sector Analysis for 2010 
    Latest: Performance Of Banking Stocks | Banking Sector Report

  • Complete coverage - Budget 2011

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