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I Am Happy that State Bank of India's Profit Fell by 62%

Feb 12, 2016


The country's largest bank the State Bank of India (SBI) declared its results for the period October to December 2015 (or what analysts like to call the third quarter) yesterday. And the results were disastrous with the net profit falling by 61.7%.

The second largest public sector bank, the Punjab National Bank, declared its results for October to December 2015, earlier this week. And its results were even more disastrous than that of SBI, with the net profit falling by 93%. In fact, the bank would have made huge losses if not for tax reversals of Rs 910 crore.

Banking is a stable business, where banks borrow at a certain rate of interest and lend at a slightly higher rate of interest. Of course everybody who takes a loan does not repay it. But if banks keep provisioning (i.e. setting aside money) for such loans in a proper way, such a huge fall in net profit, can only happen under exceptional circumstances.

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Over the last one year, I have written in great detail about the mess that public sector banks are in. And it's all coming out in the open now. In fact, many banks have been evergreening their loans by giving fresh loans to borrowers so that previous loans can be repaid.

Further, they have been under-declaring their level of bad loans by restructuring loans and kicking the can down the road. Nearly 40% of the restructured loans have gone bad over the last two to three years.

When a bank restructures a loan it allows the borrower a certain moratorium period of few years, in which the borrower has to pay only the interest on the loan. In some cases, interest also does not have to be paid. This is done in the hope that after the moratorium the borrower would have managed to turn around the business and be in a position to repay the loan. In some other cases, the tenure of the loan is increased.

But this facility has been abused by the banks, and loans which were bad in the first place (i.e. the borrower was not in a position to repay it), have also been restructured. This has allowed banks to pass off bad loans as restructured loans and continue to present a rosy set of numbers.

The Reserve Bank of India governor Raghuram Rajan calls this the band-aid approach. In fact, this approach entails banks giving fresh loans to the promoter as well. As Rajan said in a speech he made yesterday: "There are two polar approaches to loan stress. One is to apply band aids to keep the loan current, and hope that time and growth will set the project back on track. Sometimes this works. But most of the time, the low growth that precipitated the stress persists. The fresh lending intended to keep the original loan current grows. Facing large and potentially unpayable debt, the promoter loses interest, does little to fix existing problems, and the project goes into further losses."

What Rajan is essentially saying here is that the band-aid approach followed by banks up until now has not been working. And what is needed is essentially a surgery. As Rajan said: "To do deep surgery...the bank has to recognize it has a problem - classify the asset as a Non Performing Asset (NPA)."

A loan is typically declared to be a non-performing asset (or a bad loan), 90 days after the borrower starts defaulting on the interest and principal payments. When this happens a bank can no longer continue to accrue interest on the portion of the loan that remains unpaid. It has to start making provisions i.e. start keeping money aside.

This basically means that the bank starts keeping money aside so that if the loan is totally defaulted on or partially defaulted on or the bank cannot recover enough money from the assets that it has as a collateral, then enough money has been set aside for the losses.

For the first year, after the loan has been categorised as a non performing asset, it is referred to as a sub-standard asset. On this loan, the 15% of the outstanding loan amount needs to be set aside a provision. At the end of the year, the loan becomes a doubtful asset. In this case the scale of provisioning goes up. In the first year that a loan remains a doubtful asset, the level of provisioning has to go up to 25%. In the second year, the level of provisioning has to go up to 50%. And in the third year, the loan is categorised as a loss asset and the provisioning has to go up 100%.

As Rajan said: "If the bank wants to pretend that everything is all right with the loan, it can only apply band aids - for any more drastic action would require NPA classification. Loan classification is merely good accounting...It is accompanied by provisioning, which ensures the bank sets aside a buffer to absorb likely losses. If the losses do not materialize, the bank can write back provisioning to profits. If the losses do materialize, the bank does not have to suddenly declare a big loss, it can set the losses against the prudential provisions it has made. Thus the bank balance sheet then represents a true and fair picture of the bank's health, as a bank balance sheet is meant to."

And this is precisely what has happened with banks like State Bank of India and Punjab National Bank. Let's understand this in the case of the State Bank of India. The non-performing assets of the bank went up by Rs 20,692 crore (or what are referred to as fresh slippages). The number was at Rs 5,875 crore during the period July to September 2015. This implies a huge jump. What does this tell us? It tells us very clearly that the bank is finally recognising that there is a problem and that has led to this huge jump in non-performing assets. And that is a good thing.

The net increase in gross non-performing assets is Rs 15,959 crore after adjusting for recoveries and write-offs (i.e. loans on which 100% provisioning has been carried out).

Given that the fresh slippages have gone up by Rs 20,692 crore, the provisioning against these bad loans (i.e. setting aside money) has also gone up. The provisioning has gone up by 58.9% to Rs 7,645 crore, in comparison to the same period in 2014. This means more money is now being set aside to tackle the problem of bad loans. And this is the main reason why the bank's net profit fell by 61.7% to Rs 1,115 crore. Interestingly, the operating profit of the bank (earnings before tax and provisioning) went up by 2.25% to Rs 9,598 crore.

This trend is visible right across public sector banks in their third quarter results. It tells us very clearly that the Rajan led RBI is cracking the whip and forcing banks to project a correct state of affairs. And that is a good thing as Rajan explained in his speech. I hope this continues in the coming months because the first step to tackling a problem is to recognise that it exists.

Vivek Kaul is the Editor of the Diary and The Vivek Kaul Letter. Vivek is a writer who has worked at senior positions with the Daily News and Analysis (DNA) and The Economic Times, in the past. He is the author of the Easy Money trilogy. The latest book in the trilogy Easy Money: The Greatest Ponzi Scheme Ever and How It Is Set to Destroy the Global Financial System was published in March 2015. The books were bestsellers on Amazon. His writing has also appeared in The Times of India, The Hindu, The Hindu Business Line, Business World, Business Today, India Today, Business Standard, Forbes India, Deccan Chronicle, The Asian Age, Mutual Fund Insight, Wealth Insight, Swarajya, Bangalore Mirror among others.

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11 Responses to "I Am Happy that State Bank of India's Profit Fell by 62%"

Subramaniam K V

Feb 13, 2016

Very correct and very relevant. If India should develop, it is very much necessary to face the situation correctly.
Further it would be interesting to know how much of the loss is due to political compulsion.


Ajay Gupta

Feb 12, 2016

I am getting eager to know does financial institutions like Banks do give loans, without taking any collateral, then why this situation arises?


V U Sreekumar

Feb 12, 2016

Kudos to you in forecasting the predicament the P S Banks are in ,largely due to the window dressing they were resorting to over the years to hoodwink the investors and the owner alike !



Feb 12, 2016

Congratulations to Mr Vivek Kaul for highlighting the malaise prevalent in the banking industry in India. However, no one is talking about the people responsible for creating the mess and punishing them. Losses in the PSU is taxpayers' money and therefore, teh culprits should be brought to books. Why do not the Government or RBI name and shame such people. Am I using a strong word, if I call them anti-national?

Like (1)


Feb 12, 2016

Recognising NPA for what it is, is important. And so is provisioning. But what about action against bankers who sanctioned it and the fat cats that are enjoying their "wealth". This is same country where thousands of small borrowers commit suicide to not suffer the ignominy of bank action on their defaulted loans...shame on RBI...and Govt of India.

Like (1)


Feb 12, 2016

Recognising NPA for what it is, is important. And so is provisioning. But what about action against bankers who sanctioned it and the fat cats that are enjoying their "wealth". This is same country where thousands of small borrowers commit suicide to not suffer the ignominy of bank action on their defaulted loans...shame on RBI...and Govt of India.

Like (1)

AB Pereira

Feb 12, 2016

I have always liked the author for calling the spade, a spade! At the same time, as a global banker and a CA, have known this art of 'window dressing' or 'kicking the can down the road'. I too have stayed away from these banks for the last 3-4 years (except shorting them when the occasion arises, such as now).
Now my question to you Mr Vivek Kaul and others at EquityMaster is, Isnt this a fraud on investors? Not the declaring of bad results, but not declaring them earlier when they were actually bad! Shouldn't there be class action suits against these banks - the boards (including the MoF nominees), their managements, their auditors, the RBI (for closing its eyes till now) etc? My question also is, did all this problem occur just this quarter? I guess, EquityMaster can take this initiative on behalf of all its investor community.

Having said the above, I also feel that all the problems are still not declared in this quarter! Window Dressing is still being carried on. Many banks did not want to disclose losses, so they have declared some nominal profits for this quarter and have deferred the bad news to the subsequent quarters, so that the pain of loss can be moderated!

Like (1)

PV Ramana Sarma

Feb 12, 2016

.What is important is that a major percentage of these bad loans are from influensial politicians who are willful defaulters. Real whip should be cracked on them, putting them in jail if necessary. RBI should make it obligatory for all banks to declare the names of the defaulters along with quarterly results and what action is contemplated to recover the loans.

Like (1)

Someshwar Nath

Feb 12, 2016

We always knew that the Banks were hiding or evergreening the NPAs. What is pertinent is that whether the full extent of NPAs are being revealed now or whether these are being done in bits and pieces, depending upon the examination by auditors.

What is disappointing is that the statutory auditors appointed by RBI fail to identify these stressed assets during their quarterly/annual review of Bank's books.They may be doing it knowingly under pressure of Bank management or is it due to incompetency? Such auditors should be taken to task.

Like (1)

Girish Patkar

Feb 12, 2016

If Dr, Rajan had succumbed to pressure, and not gone after the Banks with all his might and resolve to get rid off the poison in the banking system by way of loans defaults, Bankers would have continued to hide bad loans. The next step is to name the defaulters,take over management control immediately and plug leakages. Banks need to overhaul the managements by bringing in professionals and ensuring that family managements are divested of all authority.

Housing finance Companies are also hiding bad loans ! Who is going after them?


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