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Banking: Better times ahead

Feb 27, 2003

The Economic Survey report for FY03 on the banking sector is out and it indicates a dynamic year. Falling interest rates, excess liquidity and a pick up in non-food credit were the salient features for FY03. However, the most important development for the sector was the enactment of the ‘Securitisation, Reconstruction of Financial Assets and Enforcement of Security Interest Act 2002’ that gave substantial powers to the lending institutions. This new law gives lenders the power to take over assets of defaulters, which was not possible in the past. The central bank, also took measures to soften the interest rate scenario by further reducing the bank rate (the rate at which RBI lends to commercial banks) to 6.25% from the earlier 6.5%. The RBI has been pursuing a soft interest policy to pepper industrial growth. Lower interest on loans is an incentive for the industry to invest in businesses as the break-even point is lowered.

While the measures taken by the RBI have helped reduce the interest rates, it is interesting to observe that the Prime Lending Rates (PLRs) have fallen at a slower rate than the deposit rates. This indicates that the benefit of lower lending rates is being gradually passed on to the industrial sector. However, it is the larger corporates that have benefited. Infact, both Reliance and Hindalco have placed papers in the sub 7% range. However, the benefits of the decline in interest rates are yet to significantly trickle down to the smaller industries that have a lower credit rating.

On the operational front, the RBI helped increase the liquidity in the markets by reducing the CRR (Cash Reserve Ratio) to 4.75% from 5% in October 2002. Softer interest rate bias as well as increased liquidity helped grow the banks’ credit by 17.3% in the current financial year up to January 10th 2003, compared to 11.0% in the same period last year. The robust growth was partially on account of the merger of ICICI Bank with ICICI. Not accounting for this merger the growth in bank credit stood at 9.7%. What was disturbing however, is the fact that food credit showed a de-growth of 7.1% till January 10th 2003 compared to a 33% growth in the same period last year. This results in the fall of food credit as a percentage of total credit to 7.2% compared to 9.4% in the same period last year.

Non-food credit growth was 19.7% in the period up to January 10th 2003 compared to 9.1% in the same period last year. Not accounting for the merger (ICICI Bank with ICICI) this growth was reduced to 11.4%. Though the growth figure was higher than previous year, it still continues to be a cause for concern. This is because of the fact that a significant part of the incremental non-food credit off take has been due to banks lending to the retail sector. While the break up is not available there is a possibility that credit off take from the industry is likely to have been sluggish.

Bank investments in G-Secs and other approved securities increased to 36.5% of total net demand and time liabilities. This is in comparison to the Statutory Liquidity Requirement (SLR) of 25% stipulated by RBI. Investment in G-Secs has further increased in the current year. This indicates that banks have been faced with excess liquidity and have been forced to invest in G-Secs due to the lack of availability of investment options that are safe and provide decent returns.

The non-SLR investments of banks have also been on the upswing. Non-SLR investments of banks stood at Rs 111 bn at the end of January 10th 2003, compared to Rs 26 bn in the same period last year. This has been due to the fact that corporates with good credit ratings have been aggressively raising capital from the debt markets by issuing bonds and debentures. They have capitalized on the low interest rate scenario and high liquidity in the markets. Banks, which have a few options to invest, have been investing in these debt instruments to protect the quality of their investment portfolio. These investments yield returns that are below PLR.

Public sector banks outperform
  Growth in FY02 in
Particulars Interest income Provisions Net profits Total assets
SBI group banks 13.5% 49.8% 55.3% 11.5%
Public sector banks 10.5% 41.0% 92.4% 12.2%
New private sector banks 21.5% 83.2% 21.3% 121.4%
Old private sector banks 8.3% 55.2% 100.0% 10.3%
Foreign banks 2.4% -6.7% 57.9% 9.8%
All schedule commercial
banks (SCBs)
10.3% 36.6% 80.7% 18.5%
Source: Economic Survey 2003

Operating performance of scheduled commercial banks indicates a considerable improvement in topline as well as bottomline. Scheduled commercial banks (SCBs) have reported a 10% growth in interest income in FY02. Clearly the new private sector banks have performed better than their peers. But it must be kept in mind that this is at a lower base. Net profit growth of SCBs has shown a considerable improvement as they have grown by 80.3% in FY02. This is despite the fact that they have resorted to aggressive provisioning to clean up their books. Provisioning for the total banking sector has increased by 36% in FY02. Falling employee expenses and robust growth in other income of PSU banks helped to improve the earnings growth. Other income for SCBs has shown a 42% increase in FY02.

NPA analysis
  Growth in gross NPAs Net NPAs as a % of advances
Particulars FY01 FY02 FY01 FY02
Public sector banks 3.1% 3.4% 6.7% 5.8%
Private sector banks 25.2% 95.7% 5.4% 5.7%
Foreign banks 18.8% -12.2% 1.8% 1.9%
All SCBs 5.5% 11.2% 6.2% 5.5%
Source: Economic Survey 2003

There was a considerable increase in the gross NPA levels of private sector banks. This can be attributed to the merger of ICICI and ICICI Bank. Foreign banks were however able to reduce their NPA levels due to the fact that their recoveries were more than additions in NPAs. But despite the growth in NPAs, SCBs have been able to reduce the net NPAs to net advances ratio indicating an improvement in the asset quality of these banks. This is mainly due to the fact that they have made aggressive provisions for NPAs.

The benefit of RBI’s soft interest rate regime and the government’s ‘Securitisation, Reconstruction of Financial Assets and Enforcement of Security Interest Act 2002’ have helped banks to a considerable extent. Banks now have better asset quality due to recovery and aggressive provisioning. The earnings gains made during the period under review is a one time affair, as falling interest rate scenario aided banks booking significant portfolio gains. This is reflected in the other income. Though the performance is skewed, with improving policy environment and the boom in retail credit off-take we can expect good times for the banking sector, atleast in the near future. Dependency on monsoons for increased food credit off-take, however, remains a concern.

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