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PSU Banks: Worth investing?

Dec 17, 2004

Mammoth balance sheet sizes, bloated work force and lack of operating efficiency are some of the common characteristics associated with PSU banks. To shake off this image and get rid of their government legacy, PSU banks are now seeking more autonomy. As opposed to the common perception, these banks are also striving to catch up with their private sector counterparts, in all respects. To assess the future potential of these banks, we take a closer look at the fundamentals of four major public sector banks in India, based on certain select parameters.

Capital Adequacy (CAR):  Most PSU banks have achieved a consistent growth in their networth over the past few years, although SBI dwarfs all its contemporaries in this respect. The obligation to comply with the Basel II norms by FY05 (which will require banks to have a minimum CAR of 12.5% as opposed to 9.0% currently) will necessitate banks to seek more capital if they have to grow their loan assets. However, if the government does not chip in with its share of capital contribution, banks will have to generate internal resources to comply with Basel II. This may mean pruning dividends to capitalise earnings. If dividends are restricted, PSU bank stocks may lose some allure.

Asset base:  PSU banks have been actively pursuing the retail segment, trying to mimic the success of private sector banks in this space. These banks have also seen their retail assets grow by around 25% per annum over the last couple of years and this rate could accelerate to 33% in FY06 (Source: IBA). Whether it is home loans, personal loans, credit cards or ATMs, PSU banks have been ramping up fast. This augurs well for these banks, as their reach in smaller towns and rural areas is better than most private sector banks.

Asset quality:  Strict credit appraisal, higher provisioning and close monitoring of asset quality are some of the initiatives that have enabled the PSU banks to bring down their NPA levels. The implementation of the amendment to Securitisation Act is expected to further support this cause, as it will succeed in bringing the willful defaulters to books.

Return on investment:  In spite of having the lowest capital base, Corporation Bank and Oriental Bank have given optimum return on investment to their shareholders. In all fairness, SBI also, in spite of its mammoth asset base and priority lending obligations, has shown consistency in enhancing its shareholder wealth.

Operating efficiency:  From garnering low cost funds to offering VRS to employees, every possible route has been employed by these banks, to shed their extra flab and improve on their operational efficiency.

FY04SBIBOICorp BankOBC
CAR (%) 13.5 13.0 20.1 14.5
Int income/working fund 8.0 7.2 8.6 8.9
Non Int income/working fund 2.0 2.2 2.0 1.9
Operating pft/wkg fund 2.5 2.8 3.5 4.1
Business/emp(Rs m) 21.1 26.7 36.6 41.6
Profit /emp(Rs m) 0.2 0.2 0.5 0.5

Investment potential

With most PSU banks (Bank of Baroda and Punjab National Bank to name a few) now accessing the capital markets, to raise funds for expansion, investors need to be wary of their fundamental strength before taking their investment decisions. A lot of investors jump into the capital market in a bull run, hoping to make hay when the sun is shining. This may be in spite of their understanding, that the concerned bank may not be a worthwhile investment. The idea is that in a bull run, everything will fly, irrespective of the fundamentals. Such a strategy seems to rely on the ‘bigger fool’ theory. But one must remember, that this strategy could backfire. Research is the key to successful investing, whether in a bull or a bear run.

Our long term investment perspective continues to be positive for Indian public sector banks, given the fact that most of our worries are counterbalanced by positives, which include sound financials, a steady reduction in NPAs, better recoveries and the industry's renewed focus on retail lending. This may just be the right time to go value buying.


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