The Reserve Bank of India (RBI), for once, at the risk of displeasing the North block, has taken an independent stand with regard to its monetary measures. The same has been reiterated every time the RBI governor made a statement pertaining to the impending liquidity constraints. While it is pertinent for the economy to withhold sufficient liquidity for clocking an average annual growth rate of 9% (as has been targeted), the inflationary concerns act as stumbling blocks.
Faced with an imminent shortage of capital, banks are expected to find it increasingly difficult to exploit lending opportunities going forward. We believe that the demand for credit from the following sectors will fail to alleviate the problem.
Retail lending: Retail lending in India has grown at a compounded annual growth rate of 30% over the past five years and the outstanding retail loan exposure of the banking sector currently comprises 26% of the gross non-food credit. With this, the share of the industry has declined from 43% in FY05 to 39% in 9mFY07. Despite the RBI's forbidding governance on the high risk-weighted loans by way of higher provisioning, the heavy exposure to the retail segment (especially in case of the new private sector banks) is unlikely to subside.
|Non food credit
||% of total disbursements
| - Housing
| - Credit cards
| - Other personal loans
|Real estate loans
Agricultural loans: The government has been urging banks to enhance credit to agricultural borrowers rapidly in the past three to four years. The RBI has also set a target of minimum 18% of lending towards agriculture (out of the overall 40% priority sector requirement), the non-compliance to which is expected to attract a penalty. The public sector banks, in particular, have increased their thrust towards this sector. With a continuing government focus on the rural sector, the agricultural lending portfolios of banks are expected to call for additional capital. Having said that, with the rising interest rates, banks could be taking on more risk in agriculture lending than they were taking earlier.
Capex plans and infrastructure funding: Investment plans by the corporate and infrastructure sectors have risen sharply over the past three years, driven by over utilisation of existing capacities, firm pricing power and an apparent infrastructure shortage. The total capital expended by the listed Indian corporates was to the tune of Rs 2,100 bn (US$ 47 bn) in FY06 and as per the CMIE data, the proposed or announced greenfield ventures are expected to consume US$ 700 bn of capital over the next three to five years.
Infrastructure lending, despite its high growth potential, poses several risks to the banking sector. These projects typically have a long duration, with funding for projects involving disproportionately high leverage. Also, banks currently, do not have adequate sources of long-term liabilities to take significant exposure to infrastructure lending, with reasonably matched liquidity and interest rate durations. In addition, a substantial increase in interest rates can change the viability of the projects, affecting credit quality of existing exposure and potential growth for future projects.
Overseas acquisitions: Encouraged by the high profitability, buoyant demand and new opportunities offered by the liberated global markets, corporate India is embarking on a global acquisition spree. The overseas M&A funding is an opportunity for banks for earning interest as well as fee income through their forex, derivatives business and M&A advisory services. However, it also places additional funding requirements, particularly constraining the liquidity in the domestic economy as companies purchase dollar denominated funds for their overseas purchases.
Capital raising options
Banks have responded to the liquidity challenges over the past couple of years by issuing equity and hybrid capital. However, the room for raising additional capital is reducing rapidly, given that banks cannot continuously dilute their equity due to the high cost of equity. The pressure on liquidity in the present economic scenario, coupled with increased provisioning and capital requirements, gives rise to a need for a cost-effective funding tool. By securitising the existing loans, banks can free up funds for lending without diluting equity, or incurring the constraints of additional deposits. This source of funds, works out to be approximately 50 to 80 basis points cheaper than wholesale deposits. This is mainly on account of the significant reserve requirements for deposits in the form of cash reserve ratio (CRR) and statutory liquidity ratio (SLR), which dampen returns. Also, securitisation would provide additional benefits like asset-liability matching and efficient risk mitigation.
The legendry investor Mr. Warren Buffet in his '20-hole punch card' investing philosophy (allowing only 20 investments over the course of our lives), emphasized that excess liquidity and crowd hype make a lot of intelligent people bad investors. The same applies to the economy as well. Instead of only being worried about arranging additional liquidity, diligent usage of the available liquidity can proficiently help us churn the growth wheel.