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Banks: Prudence warranted

Feb 6, 2003

Falling credit off take from the industrial sector has forced most of the scheduled commercial banks to park their funds in government securities (G-Secs). As long as the interest rates were falling these banks were able to book profits on their investments as the value of these investments was going up. The concern now is that when the interest rates do show signs of an upward movement, the value of the banks investments in G-Secs will fall. This loss in value will have to be written off against the reserves and the banks that have not been able to hedge their positions adequately may see their net worth eroding considerably. This risk is especially of significance in case of smaller banks. Larger and well-established banks may have adequate checks and balances in place to counter any fall in the value of their G-Sec investments. But there are still concerns that there may be significant erosion in value of net worth of some banks.

Around 25% of the bank funds have to be parked for statutory liquidity requirements (SLR). Out of the SLR investments, a maximum of 25% has to be parked in a category called HTM (held to maturity). The rest has to be parked in available for sale (AFS) as well as held for trading (HFT) portfolios. The HTM portfolio does not have to be marked to market and hence the banks cannot book profits or show losses in this portfolio. The other two portfolios on the other hand, are the problem areas. Banks cannot book profits in the AFS portfolio whereas it will have to show losses if it incurs any. The HFT portfolio, as the name suggests, has to maintain the portfolio at current day prices, showing gains or diminution in value of investments.

(Rs bn)* Net worth Investments Investments in G-Secs % of total
ICICI Bank 66 359 227 63.3%
HDFC Bank 19 120 53 44.1%
IDBI Bank 3 24 15 63.3%
UTI Bank 6 66 36 55.0%
Corporation Bank 20 81 59 72.8%
*FY02 figures

Apart from worries over the interest rate scenario there are also concerns about the aggressive retail thrust of commercial banks. On an average it takes nearly 3-4 years for a bank's retail operations to breakeven. So retail investors should not be enamoured by the aggressive retail thrust of some of the private sector banks in the country. In order to expand the retail market, banks have been aggressively setting up infrastructure like ATMs and branches. This will only help in delaying breakeven of its retail operations. Investors may want to look into the per branch efficiency parameters of the banks. This is a better indicator of the efficiency of banks.

Also retail loans (mainly home loans) have been touted as relatively less risky. But our interaction with the industry indicates that the true picture of the assets quality will only be apparent once the assets are seasoned, i.e. in the next 3-4 years. Under these circumstances investors may be better off investing in banks that have an established track record of maintaining good asset quality and growth vision going forward. All in all, banking stocks are good investments, but it is absolutely critical to research on their growth going forward and whether their aggression meets your risk profile.


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