X

Sign up for Equitymaster's free daily newsletter, The 5 Minute WrapUp and get access to our latest Multibagger guide (2017 Edition) on picking money-making stocks.

This is an entirely free service. No payments are to be made.


Download Now Subscribe to our free daily e-letter, The 5 Minute WrapUp and get this complimentary report.
We hate spam as much as you do. Check out our Privacy Policy and Terms Of Use.
Banks: Where to from here? - Views on News from Equitymaster
 
 
  • PRINT
  • E-MAIL
  • FEEDBACK
  • A  A  A
  • Dec 6, 2004

    Banks: Where to from here?

    The recent report released by the Reserve Bank of India (RBI) on the Trend and Progress of Banking in India is an eye-opener in many sense. As against the common belief that public sector banks are 'elephants that cannot dance', there are some interesting facts that shows that all is not bad! We take a closer look at the non performing assets (commonly referred as NPAs) side of the banking sector and what lies ahead?

    The table below highlights the trend in NPAs of the banking sector with respect to its players i.e. public sector undertakings, private sector and foreign banks.

    Who said PSUs are not efficient?
      FY01 FY02 FY03 FY04
    Public sector banks        
    Gross NPAs/Advances 12.4% 11.1% 9.4% 7.8%
    Net NPAs/Advances 6.7% 5.8% 4.5% 3.0%
    Private sector banks        
    Gross NPAs/Advances 8.4% 9.6% 8.1% 5.8%
    Net NPAs/Advances 5.4% 5.7% 5.0% 2.8%
    Foreign banks        
    Gross NPAs/Advances 4.6% 5.3% 5.4% 6.8%
    Net NPAs/Advances 1.5% 1.8% 1.9% 1.8%
    Source: Trends and progress of banking in India

    To start of with, the ratio of gross NPAs to advances has declined in the last four years for private sector and PSU banking majors. There are various reasons for the same, cyclical and structural. Firstly, demand for credit from the corporate sector has been lacklustre in the last four years (a cyclical factor). So, barring the sharp rise in retail loan portfolio of the banking sector (that has lower defaults), banks have not really witnessed any significant growth in advances to corporates in the last four years. This means that the additions to NPAs have been slower. Secondly, the passing of the Securitisation Act has strengthened the backbone of the financial sector and consequently, loan recovery rates have improved (a structural factor). Thirdly, banks themselves have become more cautious while lending loans to corporates, unlike the mid-1990s. However, what is surprising is the consistent rise in gross NPAs as a percentage of advances ratio of foreign banks over the last four years. Who said foreigners are better?

    While it is evident that both the private sector and PSUs have managed to bring down Net NPAs as a percentage of advances over the last four years, the decline has been faster for PSUs (assuming that a bank had gross NPA of Rs 100 in FY04, of which it provided for Rs 20 from its profits, the Net NPA at the end of the year will be Rs 80. This explains the difference between the gross and the net NPAs). The banking sector, as a whole, was able to clean up their balance sheet in a significant way because of the sharp fall in interest rates during this period. With demand for corporates remaining lacklustre, most of the banks had parked significant sums in government securities, well above the statutory requirements. With interest rates softening, the value of the securities portfolio of banks appreciated dramatically, which in turn enabled banks to write-off NPAs at a faster rate.

    As the report by RBI itself states "treasury income of the banking sector increased from Rs 95 bn in FY02 to Rs 195 bn in FY04 and constituted 32% and 37% of operating profit in the corresponding years. This in turn enabled banks to make larger loan loss provisions. Consequently, the net NPA ratio has declined from 5.5% in FY02 to 2.9% by FY04". As is evident from the table above, there is not much difference between net NPA to advances ratio between PSU and private sector banking majors!

    However, the difference arises when one considers the sectoral composition of NPAs of the private sector and PSU banks. Priority sector lending, including advances to the agricultural sector, accounts for bulk of the NPAs of public sector banks (almost twice as much the private sector peers). Since most of the private sector banks are urban focused unlike PSU banks, they have an advantage. PSUs, on the other hand, have carried the burden of being government owned and therefore, have social obligations.

    The sources of NPAs - Priority sector disadvantage for PSUs
    (% total NPAs) Old private sector New private sector Private sector SBI Group Other PSUs Total PSUs
    Agriculture 6.6% 2.9% 4.4% 16.5% 13.6% 14.4%
    SSIs 19.5% 6.8% 12.2% 15.0% 18.7% 17.6%
    Public sector 0.2% 1.1% 0.7% 1.5% 1.1% 1.2%
    Non-priority sector 58.9% 87.5% 75.3% 51.5% 51.1% 51.2%
    Others 14.9% 1.8% 7.4% 15.5% 15.5% 15.5%
    Total 100.0% 100.0% 100.0% 100.0% 100.0% 100.0%
    of which priority sector 40.9% 11.4% 24.0% 47.1% 47.7% 47.5%
    Source: Trends and progress of banking in India

    What to look for?

    Demand for non-food credit has increased in the last one year indicating that the much awaited investment recovery is taking shape. While this could mean higher growth in advances for the banking sector as whole, not all banks have proper risk management system and technology to support this expansion. This could mean that the gross NPA to advances ratio could increase in the future.

    As discussed earlier, the banking sector was able to clean up their balance sheet from robust trading profits. With interest rates expected to increase in the future, this benefit is no longer available for banks and therefore, the sustanence of the current low net NPAs to advances ratio is doubtful. Investors have to exercise caution on this front.

    "To improve flow of credit to small and marginal farmers, the banks have to make efforts to increase their disbursements to small and marginal farmers to 40% of their direct advances by March 2007. All private sector banks also to formulate targets from the year 2005-06, with an annual growth rate of at least 20% to 25% of credit disbursements to agriculture" - one of the major policy developments in 2004. Since the agricultural sector is highly dependent on monsoons, risk of default exist and consequently, the return ratios of both private sector and PSUs could come under pressure. Private sector banks are faced with a new challenges on this aspect.

    While de-regulation brings with it whole host of growth opportunities, we believe that valuations of banking stocks at the current juncture is on the higher side, with respect to their growth prospects in the medium-term. With the sector moving towards tighter provisioning and capital adequacy norms, we believe that only few banks have the management depth and balance sheet strength to overcome these challenges. Given this backdrop, probably, banking on better credit growth prospects alone may not be the right strategy as far as investing in bank stocks are concerned.

     

     

    Equitymaster requests your view! Post a comment on "Banks: Where to from here?". Click here!

      
     

    More Views on News

    SBI: Asset Quality and Slow Credit Remain Achilles' Heel (Quarterly Results Update - Detailed)

    Aug 22, 2017

    State Bank of India (SBI) continues to battle sliding asset quality and sluggish credit growth.

    IDFC Bank: Strong Trading Income Shields Credit Slowdown (Quarterly Results Update - Detailed)

    Aug 10, 2017

    IDFC Bank is taking steps to address contracting NIMs and successfully transition in to a retail bank.

    ICICI Bank: Loan Slippages Trending Downwards (Quarterly Results Update - Detailed)

    Aug 10, 2017

    Asset quality will be the key thing to watch out for going forward.

    Should You Take SBI Chief's Advice and Load up on SBI Shares? (The 5 Minute Wrapup)

    Jul 6, 2017

    Does the stock score on the value versus price equation?

    AU Small Finance Bank Ltd. (IPO)

    Jun 27, 2017

    Should one subscribe to the IPO of AU Small Finance Bank Ltd?

    More Views on News

    Most Popular

    A 'Backdoor' to Multibaggers: It's Like Investing in Asian Paints Ten Years Ago(The 5 Minute Wrapup)

    Aug 10, 2017

    Don't miss these proxy bets on growing companies or in a few years you will be looking back with regret.

    The Most Important Innovation in Finance Since Gold Coins(Vivek Kaul's Diary)

    Aug 10, 2017

    Bill connects the dots...between money and growth, real money and real resources, gold and cryptocurrencies...and between gold, cryptocurrencies, and time.

    Signs of Life in the India VIX(Daily Profit Hunter)

    Aug 12, 2017

    The India VIX is up 36% in the last week. Fear has gone up but is still low by historical standards.

    Bitcoin Continues Stellar Rise(Chart Of The Day)

    Aug 10, 2017

    Bitcoin hits an all-time high, is there more upside left?

    5 Steps To Become Financially Independent(Outside View)

    Aug 16, 2017

    Ensure your financial Independence, and pledge to start the journey towards financial freedom today!

    More
    Copyright © Equitymaster Agora Research Private Limited. All rights reserved.
    Any act of copying, reproducing or distributing this newsletter whether wholly or in part, for any purpose without the permission of Equitymaster is strictly prohibited and shall be deemed to be copyright infringement.

    LEGAL DISCLAIMER: Equitymaster Agora Research Private Limited (hereinafter referred as 'Equitymaster') is an independent equity research Company. Equitymaster is not an Investment Adviser. Information herein should be regarded as a resource only and should be used at one's own risk. This is not an offer to sell or solicitation to buy any securities and Equitymaster will not be liable for any losses incurred or investment(s) made or decisions taken/or not taken based on the information provided herein. Information contained herein does not constitute investment advice or a personal recommendation or take into account the particular investment objectives, financial situations, or needs of individual subscribers. Before acting on any recommendation, subscribers should consider whether it is suitable for their particular circumstances and, if necessary, seek an independent professional advice. This is not directed for access or use by anyone in a country, especially, USA or Canada, where such use or access is unlawful or which may subject Equitymaster or its affiliates to any registration or licensing requirement. All content and information is provided on an 'As Is' basis by Equitymaster. Information herein is believed to be reliable but Equitymaster does not warrant its completeness or accuracy and expressly disclaims all warranties and conditions of any kind, whether express or implied. Equitymaster may hold shares in the company/ies discussed herein. As a condition to accessing Equitymaster content and website, you agree to our Terms and Conditions of Use, available here. The performance data quoted represents past performance and does not guarantee future results.

    SEBI (Research Analysts) Regulations 2014, Registration No. INH000000537.

    Equitymaster Agora Research Private Limited. 103, Regent Chambers, Above Status Restaurant, Nariman Point, Mumbai - 400 021. India.
    Telephone: +91-22-61434055. Fax: +91-22-22028550. Email: info@equitymaster.com. Website: www.equitymaster.com. CIN:U74999MH2007PTC175407
     

    Become A Smarter Investor In
    Just 5 Minutes

    Multibagger Stocks Guide 2017
    Get our special report, Multibagger Stocks Guide (2017 Edition) Now!
    We will never sell or rent your email id.
    Please read our Terms

    S&P BSE BANKEX


    Aug 22, 2017 (Close)

    S&P BSE BANKEX 5-YR ANALYSIS

    COMPARE COMPANY

    MARKET STATS