Another Reason for PSBs to Worry About

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Banking sector in India has been in the news for quite some time now. The sharp spike in loan write-offs, mounting NPAs, and a steep fall in profits of Indian banks are some of the factors that have kept this sector in a hall of shame. And to be more specific, public sector banks (PSBs) have topped the list for fueling most of the trouble here. Poor credit appraisal, over leveraging, the practice of taking fresh loans to pay off old ones, and leaving the mess for the successor managements to clear up are some of the practices in PSBs that have posed a potent risk for the entire economy.

The latest concern for PSBs is the question of their ability to service interest on their own bonds. This comes as credit ratings agency Crisil recently raised a red flag for six public sector banks. The agency has stated that negative or low revenue reserves coupled with a decline in profitability could make some PSBs vulnerable and hamper their ability to service coupons on their additional Tier 1 (AT1) bonds.

Going by the numbers, as many as 14 PSBs have Rs 226 billion of AT1 bonds outstanding. Why this is worrisome is because the interest on these bonds can only be serviced through current year's profit or from the revenue reserves.

During the last year, 13 out of 21 PSBs reported losses for FY16. Almost half of these 21 banks are said to do so again in FY17. If this becomes the case, the only resort left with banks to repay interest on AT1 bonds is revenue reserves.

What is the position of revenue reserves of PSBs? As per the Crisil report, six banks from the above lot have negative or low revenue reserves. Of these six banks, four banks have AT1 bonds outstanding. So losses for these banks will make it difficult for them to repay the interest on AT1 bonds.

Also, there are four other PSBs which are expected to pose losses in the near term. However, they have adequate revenue reserves to service coupon on AT1 bonds outstanding. That said, their ability to continue to do so in the medium term will depend on a return to profitability.

The only way out in the above situation is an improvement in the profitability levels of PSBs. And that can't be seen if the bad loans at PSBs continue to grow.

Apart from the above, many other concerns persist for the Indian economy if the problem of bad loans at PSBs continues. Vivek Kaul, editor of Vivek Kaul's Diary, has written about the mess at PSUs and how it's one of the major problems for the Indian economy. Vivek has also explained why the government shouldn't be running 27 public sector banks.

To stay on top of big macro trends in India, like the one above, we recommend the Vivek Kaul Letter (subscription required). Vivek addresses a range of big issues in this unique newsletter - India's disastrous jobs situation, the government's handling of oil prices, the mess in public sector banks, the current state of India's real estate bubble...and a lot more!

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