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Banking Sector Analysis Report 

[Key Points | Financial Year '16 | Prospects | Sector Do's and dont's]

  • Global economy experienced turmoil in the past year. During the year gone by, central bankers across the globe other than the US, continued their policy of monetary easing measures to boost the economy, While US Fed at the end of the 2016 increased interest rates. However, the global economy continued to remain fragile with the second largest economy China witnessing a slowdown. The crude prices over the year arrested its slide and saw some stability but oversupply issues remained an anchor on the global oil prices. The International Monetary Fund (IMF) expects global growth to revive to 3.4% in 2017. Anemic global growth coupled with macro events like the Brexit, US elections resulted in uncertainties to prevail in 2016.
  • The Indian economy became the fastest growing large economy for FY16. The economy has been on a relatively sound footing, growth and stable inflation. However, problems such as a weak investment climate and tepid earnings growth continue to plague the economy. The banking sector, being the barometer of the economy, is reflective of the weak macro-economic variables. The Indian banking system continued to battle falling asset quality issues and the need to maintain capital adequacy in the light of piling bad loans.
  • The announcement of demonetisation gave a big jolt to the Indian economy. The one move effectively reseted the economy. The banking sector was the beneficiary with access to huge deposits The banking sector witnessed a balance sheet growth of 7.7 percent in 2015-16 compared to 9.7 percent a year earlier. A high and rising proportion of banks stressed loans, particularly those of public sector banks (PSBs) and a consequent increase in provisioning for non-performing assets (NPAs) continued to weigh on credit growth reflecting their lower risk appetite and stressed financial position. However, profitability recorded a substantial decline resulting in lower Return on assets (RoA) at 0.3% during the year.
  • The ownership in the banking sector remained predominantly in the public sector despite a gradual decline in their share.
  • The Reserve Bank of India (RBI) has continued to reduce interest rates. The repo rates stand at 6.25%. Although banks have reduced base rates but not to the same extent. For the full transmission of rates, the RBI has asked banks to follow the marginal cost of funds while setting the base rate.
  • Per RBI data, Credit to sensitive sectors viz. the capital market and real estate sector accounted for around 20 per cent of the total loans and advances by Scheduled commercial banks. Even among these two sectors, 92.5 per cent of the credit pertained to the real estate sector. During 2015-16, credit to both the sectors witnessed deceleration.

How to Research the Banking Sector (Key Points)

  • Supply
  • Liquidity is controlled by the Reserve Bank of India (RBI).
  • Demand
  • India is a growing economy and demand for credit is high though it could be cyclical in nature.
  • Barriers to entry
  • Licensing requirement, investment in technology and branch network, capital and regulatory requirements.
  • Bargaining power of suppliers
  • High during periods of tight liquidity. Trade unions in public sector banks can be anti reforms and orchestrate strikes. Depositors may invest elsewhere if interest rates fall.
  • Bargaining power of customers
  • For good creditworthy borrowers bargaining power is high due to the availability of large number of banks.
  • Competition
  • High- There are public sector banks, private sector and foreign banks along with non banking finance companies competing in similar business segments. Additionally, the RBI has approved for small finance banks and payment banks which will further increase competition in the industry.

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Financial Year '16

  • The domestic economy growth remained muted, the growth in the Indian banking sector too remained under pressure in FY16 as well. Advances rose 11.3% in FY16, the asset quality review initiated by the central bank resulted in an increased recognition of bad loans. Thus higher provisioning and write-offs stifled banks advances growth. Poor earnings growth by companies, slow pace of investments, risk aversion of banks due to rising bad loans, and availability of alternative funding sources for corporates pulled down credit growth during the year. Similarly, the growth in deposits of scheduled commercial banks (SCBs) at 11.3% in FY16 was much lower than the growth at 10.7% in the previous financial year. The median base rate of major banks came in at 9.65% in FY16. Even deposit rates have steadily fallen in the financial year 2016.
  • There remains a wide disparity in the credit performance of public and private sector banks. While the credit growth of public sector banks has marginally increased by 2.0% that of private sector banks has improved from 17% to 19.8% in FY16.
  • The net interest margin (NIM) witnessed decline during the year due to loss of interest from standard assets slipping into NPAs, the impact of implementation of the Ujwal DISCOM Assurance Yojana (UDAY) leading to lower yields and adoption of the marginal cost lending rate (MCLR) during a decreasing rate scenario. Lower costs of funds could not offset the decline in NIM. Spread marginally increased in 2015-16.
  • In terms of profitability, the return on assets (RoA) declined substantially to 0.3% whereas the return on equity (RoE) dipped from 10.4% to 3.6% in FY16. Among banks, public sector banks reported a negative RoA from 0.46% to -0.2%. Private sector banks saw their RoA decline from 1.68% to 1.50% during the year.
  • The Net NPA to Net advances by public sector banks increased from 2.92% to 5.75% in FY16. The rise in stressed assets continued after the asset quality review initiated by the central bank.

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Prospects

  • The Indian economy is moving towards normalcy after demonetisation. The central bank will continue to monitor liquidity data and inflation numbers to decide on the next course of action in their monetary policy.
  • The full transmission of reduction in interest rates from the central bank is expected to be passed on by the banks to their customers in the upcoming financial year.
  • The move towards a less cash economy will incentivize increased digital mode of transactions. The ability of the government to use the database of Aadhaar as unique identifier coupled with Jan Dhan accounts created for the unbanked or people newly under the fold of banks is a huge opportunity for banks to exploit in the near future.
  • The infusion of capital to public sector banks will remain a crucial aspect for these banks since the banks are struggling with bad loans coupled with a deteriorating provision coverage ratio will mean that the banks would require capital to disburse credit. Banks must be well capitalised for them to be able to grow its credit.

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Related Links for Banking Sector
Quarterly Results | Sector Quote | Over The Years

Views on News

SBI: Stake Sale Gains Boost Earnings (Quarterly Results Update - Detailed)

Feb 28, 2017

State Bank of India (SBI) declared its results for the third quarter of the financial year 2015-16 (3QFY17). The net interest income for the quarter grew by 8% YoY and the profit was up by 134% YoY.

IDFC Bank: Bad Loan Provisions Chip Away Profits (Quarterly Results Update - Detailed)

Jan 31, 2017

IDFC Bank declared its results for the third quarter of the financial year 2016-17 (3QFY17). The bank posted a 25.8% YoY growth in interest income and 21% fall in profit during the quarter. Since the bank commenced its banking operations on 1st October 2015, the year-on-year performance for the 9mFY17 is not strictly comparable.

HDFC Bank: Growth Stumbles Post Demonetisation (Quarterly Results Update - Detailed)

Jan 30, 2017

HDFC Bank declared the results for the third quarter of financial year ending March 2017 (3QFY17). The bank has reported 18% YoY and 15% YoY growth in net interest income and net profits respectively in 3QFY17.

PNB Housing Finance IPO: Our View (IPO)

Oct 25, 2016

Equitymaster analyses Initial Public Offering (IPO) of PNB Housing Finance Ltd, one of the leading Housing Finance companies, in the country.

RBL Bank IPO: Our View (IPO)

Aug 18, 2016

Equitymaster analyses Initial Public Offering (IPO) of RBL Bank Ltd, one of the fastest growing private banks in the last six years.

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