• JULY 16, 2014

Is the worst over for Indian banks?

Banks constitute the backbone of a nation's financial system. And there is no denying the fact that the health of the economy is a mirror reflection of the banking system. Be that as it may, the economic downturn however has led to formidable challenges for the banking sector. Current slowdown- global and domestic, persistent policy logjams, delayed clearances of various projects, aggressive expansion by corporate during the high growth phase and more have left the banking system in a state of limbo. Banks have been victims of bad loans and capital insufficiencies over two years now.

While the nation applauded the change in guards at the centre, high hopes have been built-up for a turnaround in the system. And the picture seems to be turning. Albeit gradually! While it is too early to say the worst is behind for the banking sector, the recent Financial Stability Report release from the Reserve Bank of India (RBI) suggests a slow recovery is underway.

Indian banks are giving a best shot in repairing their balance sheets. Banks' average capital to risk-weighted assets ratio (CRAR), that provides a glimpse of the bank's long-term stability, has gone up from 12.7% to 12.9%. Not just that! The total stressed advances i.e. non-performing assets (NPAs) + restructured loans have come down. That they have been pared from 10.2% in September 2013 to 9.8% in March 2014 is a good sign if nor great. There has been a perceptible decline in the rate of slippage of standard loans into NPA category too. And with sales of bad loans to asset reconstruction companies (ARCs) gaining grounds, the asset quality is expected to gradually improve in the sector.

So is the worst over for the banking sector?

Certainly not! The NPA ratio over 9% of loan book is certainly high by all standards.

What's more complicating for the banking system is that it still suffers from weak credit growth. Below 14% credit growth in 2013-14 as against whopping 17%-18% over the preceding five years is rather worrisome. This may be an outcome of the conscious effort from the banks to pare down exposures to the troubled sectors of the economy. But on the flipside, capital constraints are also to be blamed for the inadequate credit expansion in the system. And if that's the case, then the economic recovery is still distant. True, that the Indian banks unlike their global counterparts have not yet experienced a major banking crisis. Even the RBI's Report pointed out that. However, challenges on the asset quality and capital adequacy fronts will persist.

There is no doubt that Indian banks particularly the PSUs ones are still short of capital to support their credit requirements. And the much needed credit growth can only uplift the saddled economy and in turn boost the investment cycle.

What is in store?

The Union Budget 2014-15 has to a certain extent helped addressing the banking sector concerns. Citing that financial stability is the foundation of a rapid economic recovery, greater emphasis has been laid out on strengthening the banking sector in the budget. However that is a lengthy process. While the RBI Report forestalls a recovery, it spells out caution too. It candidly states the challenges haunting the Indian banks for the coming quarters. Besides capital needs and asset quality, profitability and more importantly, the governance and management processes continue to add woes to the Indian banks. And public sector banks stand more vulnerable.

What should investors do?

While banking stocks should definitely form part of your investment portfolios, cherry-picking quality ones is the key. Familiarizing oneself with the key criteria for analyzing banking stocks would be a good start. Further it is important to know that price to adjusted book value and not price to earnings is a better method of valuing banking stocks.

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