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Banks: Where is the money? - Views on News from Equitymaster
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  • Aug 12, 2005

    Banks: Where is the money?

    Having posted robust performance for 1QFY06, banking entities remain the cynosure of the investor's eye, irrespective of the fact as to whether their valuations support the sentiments or not. The disturbing factor is that the 'optimism' is at times devoid of a clear outlook as to whether the performance is sustainable.

    Credit offtake propelled by a steady growth in advances across segments has been the prime driver of the recent growth. To put things into perspective, the credit to deposit ratio touched a high of 68% for the first time in 3QFY05 and the incremental credit to deposit ratio has been crossing 100% for the past couple of quarters. Also, the 28% YoY growth in non-food credit in FY05 was one of the highest in past 3 decades. While this augurs well for the banks in terms of their net interest income growth, all does not seem to be well when it comes to the funding side.

    While the pace of incremental advance growth has been accelerating at an unprecedented pace, banks seem to be falling short of funds to sustain the same. Deposit mobilisation has failed to catch up with the pace of credit growth, the impact of which is evident in the widening gap between the respective growth rates. Infact, the latter's (deposit) growth rate was a 5 year low in FY05 (at 13% YoY). Also, with incremental credit demand and Basel II compliance requirements necessitating banks to shore up their capital adequacy ratio, most banks have already exhausted the equity raising option. In case of most PSU banks, the government holding having reached 51% (minimum holding limit), the Tier I (equity) route is non-existent. Inadequate fund mobilisation is thus one of the primary dampener to the sector's growth prospects.

    The bail out route...

    Offloading investments: While on one hand, a high proportion of GSec investments are a cause of caution for banks due to the interest rate risk, the same can be a worthy bail out option in the wake of capital crunch. Higher interest rates erode the market value of investments in a rising interest rates scenario. However, if such investments are in excess of the SLR requirement, the same can be liquidated for funding credit growth. Thus, in such scenario, banks that have excess G Sec investments stand to gain as they can liquidate the investments in the event of paucity of funds. At the same time, replacing investments with higher yielding advances may aid the banks' net interest margins.

    Economising through low cost deposits: We have repetitively voiced our concerns about the shrinking net interest margins in the sector due to rise in cost of funds and time lag in passing it on to the consumers. Also, the Tier II borrowings that the banks will need to borrow, to shore up their liability base, call for additional interest costs. In such a case, banks that have higher proportion of low cost deposits (savings and demand) will stand to be better off. They will be able to stablise their margins with relatively lower cot of funds. Also, given the margin advantage, they will be in a relatively comfortable position as compared to peers for raising additional funds.

    While we do not undermine the role of banks in driving India's growth story, the point we wish to highlight is that, 'banking' as a business is no more what it used to be a decade ago. While on the one hand, de-regulation and greater autonomy are a positive, these factors have also exposed them to more competition. Let's face it!

    Banking is today a commodity business. In such a scenario and with foreign intrusion on the anvil (post FY09), the survival of Indian banks today is based on the principle of 'survival of the fittest'. Investors buying into a banking story, must therefore, not follow the herd mentality of the sector being 'hot', but carefully determine as to whether their chosen bank is also a 'fit' one. Fit in fundamental terms. Fit in valuation terms. And fit for the long term!



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