Is the worst over for Indian banks? - Views on News from Equitymaster

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Is the worst over for Indian banks?

Jul 16, 2014

Banks constitute the backbone of a nation's financial system. And there is no denying the fact that the health of the economy is a mirror reflection of the banking system. Be that as it may, the economic downturn however has led to formidable challenges for the banking sector. Current slowdown- global and domestic, persistent policy logjams, delayed clearances of various projects, aggressive expansion by corporate during the high growth phase and more have left the banking system in a state of limbo. Banks have been victims of bad loans and capital insufficiencies over two years now.

While the nation applauded the change in guards at the centre, high hopes have been built-up for a turnaround in the system. And the picture seems to be turning. Albeit gradually! While it is too early to say the worst is behind for the banking sector, the recent Financial Stability Report release from the Reserve Bank of India (RBI) suggests a slow recovery is underway.

Indian banks are giving a best shot in repairing their balance sheets. Banks' average capital to risk-weighted assets ratio (CRAR), that provides a glimpse of the bank's long-term stability, has gone up from 12.7% to 12.9%. Not just that! The total stressed advances i.e. non-performing assets (NPAs) + restructured loans have come down. That they have been pared from 10.2% in September 2013 to 9.8% in March 2014 is a good sign if nor great. There has been a perceptible decline in the rate of slippage of standard loans into NPA category too. And with sales of bad loans to asset reconstruction companies (ARCs) gaining grounds, the asset quality is expected to gradually improve in the sector.

So is the worst over for the banking sector?

Certainly not! The NPA ratio over 9% of loan book is certainly high by all standards.

What's more complicating for the banking system is that it still suffers from weak credit growth. Below 14% credit growth in 2013-14 as against whopping 17%-18% over the preceding five years is rather worrisome. This may be an outcome of the conscious effort from the banks to pare down exposures to the troubled sectors of the economy. But on the flipside, capital constraints are also to be blamed for the inadequate credit expansion in the system. And if that's the case, then the economic recovery is still distant. True, that the Indian banks unlike their global counterparts have not yet experienced a major banking crisis. Even the RBI's Report pointed out that. However, challenges on the asset quality and capital adequacy fronts will persist.

There is no doubt that Indian banks particularly the PSUs ones are still short of capital to support their credit requirements. And the much needed credit growth can only uplift the saddled economy and in turn boost the investment cycle.

What is in store?

The Union Budget 2014-15 has to a certain extent helped addressing the banking sector concerns. Citing that financial stability is the foundation of a rapid economic recovery, greater emphasis has been laid out on strengthening the banking sector in the budget. However that is a lengthy process. While the RBI Report forestalls a recovery, it spells out caution too. It candidly states the challenges haunting the Indian banks for the coming quarters. Besides capital needs and asset quality, profitability and more importantly, the governance and management processes continue to add woes to the Indian banks. And public sector banks stand more vulnerable.

What should investors do?

While banking stocks should definitely form part of your investment portfolios, cherry-picking quality ones is the key. Familiarizing oneself with the key criteria for analyzing banking stocks would be a good start. Further it is important to know that price to adjusted book value and not price to earnings is a better method of valuing banking stocks.

Tanushree Banerjee

Tanushree Banerjee (Research Analyst), is the editor of Stock Select and Forever Stocks. Tanushree started her career at Equitymaster covering the banking and financial sector stocks and scrutinising RBI policies. Over the last decade, she developed Equitymaster's research processes that helped us pick out various multibaggers, across all sectors. A firm believer of "safety first" when it comes to investing, Tanushree closely follows the investing philosophies of Warren Buffett, Jeremy Grantham, and Joel Greenblatt.

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3 Responses to "Is the worst over for Indian banks?"

K. Balasubramanian

Jun 16, 2015

The proposals of RBI -Governor will not help save PSU- Banks from the impending financial disaster . The ARCs , that bought NPAs of Banks at a steep discount , could not realise even 50% of the cash that they offered . CDRs cannot revive dead-patients . They may help a patient in coma . But many of our Corporate -patients are in deep coma , with very little chance of a revival . Bhushan Steel , JSPL , are cases in coma-stage . But cases like Winsome Diamonds , Kingfisher , Resurgere , Surya Pharma , K.S. Oils & scores of such Companies are bodies kept in ICUs , as is the practice in unscrupulous Hospitals ! The patients were dead long back , but they are kept in ICUs so that the bodies do not decompose , and the Hospitals can extract more money from anxious relatives ( Investors/ Bankers ) , by inflating ICU bills . The proposal to convert NPAs into Equity is ridiculous and would again benefit the unscrupulous Promoters only . As an example , the NPA of IVRCL Ltd was converted into equity at a price of 22.50 when the market-price was only 14+ , which is now Rs. 9.65 ! The JLF has lost heavily . Also , of what earthily use is to takeover the Management of a Company , like Winsome Diamonds , when what is leftover are a few dilapidated buildings and broken show-cases of the Jewellery , with the showcases not having even imitation-jewellery ! The price of this Company is a mere 65 paise/ share !. Of what use , will be the Factory-sheds of these dead Companies when Machineries were already sold out ? ( eg. South India Viscose Factory / HPF in Ooty .) The only way to save PSU -Banks are to implement the following steps in earnest . (1 ) . The Loans must have Collateral security to the extent of 10% of the Promoters -component in Equity , from the personal properties of the Promoters . Eg. promoter equity is 45 % in Paid-up Capital . Then if the Loan sanctioned is say, 200 crores , then 4.5% of the loan , must have been secured from personal property of the Promoter. ( Rs. 9 crores ). (2). The Auditors of the Company must be voted to Office by a majority of the Non-promoter holders , & to be ratified by the Bankers if the loan-exposure is more than the Equity ( Debt- equity of more than 1 ) ( 3) . The promoters salaries , including that of relatives , B-in-Law/ S-in- Law of CMDs are to be ratified by the Min. of Company Affairs . ( At present the higher-ups in MCA are enjoying an affair with the Corporate Sector , which must be checked with an iron fist ! ) (4) . The JLF / Lender-bank must demand a Quarterly report on loan utilisation ( LUR for each quarter ). This will check buying of properties by the Promoters in London / Dubai / Singapore/ other European capitals, using Bank-finance . Many promoters may deny this , as expected . Properties in other World capitals have appreciated with loans to Corporate Sector in India , as huge money is made in capex expenses & acquisitions with Bank-funds , by these Promoters. ( 5 ) Bank-secrecy clauses must be thrown to winds by the Employees of banks if they want their Bank to be saved from the pick-pockets of the Corporate Sector . Let us always remember that the PSU Banks are marching to join the ranks of GTBL ( Global dis-Trust Bank Ltd ) , at a hectic speed . If timely action , already it is high time , is not taken by RBI , their untimely collapse is imminent !! Jai Hind !!!

From : K. Balasubramanian , S-1/ F-2 , PGP Village , Singanallur (p.o) Coimbatore-5 . Ph. 0422-2971726 . Mob.:: 94423 37067



Mar 24, 2015

Why is the government or the banks not recovering the NPAs. Shouldnt there be a fool proof system to check the colateral or pledges of borrowers and if they do default, the government should have strict laws to immediately auction off or recover the money one way or the other OR should there be private Debt Collectors to whom the banks can sell their NPAs to.

Like (2)

Jul 18, 2014

The Indian banking sector of late is doing well.However a high NPA ratio means that banks need to be wary.They are not yet out of the woods.Banks have yet to recover a huge amount of loans.
Banks can now focus on the home loan segment and the affordable housing segment and shift focus from corporate lending.

Like (4)
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