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Banking Sector Analysis Report 

[Key Points | Financial Year '17 | Prospects | Sector Do's and dont's]

  • After facing turmoil for quite a while, global economy rebounded in the preceding year.

    The year gone by signified the beginning of the end of the easy money era. Federal Reserve hiked interest rates thrice in 2017 and the same now stands in a range of 1.25% to 1.5%. The Fed has forecasted another three rate hikes in 2018 and two hikes in 2019. The rate hike is on account of an improving economy and labour market in the US. The unemployment rate has dropped to lowest in seventeen years and now stands at 4.1%. With the US raising rates, the European Central Bank (ECB) is expected to soon follow suit.

    The crude prices over the year arrested its slide and saw some stability but oversupply issues remained an anchor on the global oil prices. Recently, the International Monetary Fund (IMF) revised upwards its global growth forecast. The IMF expects the global economy to grow by 3.9% in 2018 and 2019.

    The improved prospects of global economic growth will be positive for the banking sector.
  • Post demonetization and transition to goods and service tax (GST), the Indian economy has slowed down in FY 2017. The gross domestic product (GDP) grew by 7.1% in FY17, way lower than the 8% growth registered in FY 2016.

    The macro situation in India has deteriorated slightly on account of a spurt in the oil prices, a higher inflation then the expectation and more importantly fiscal slippages on account of lower than anticipated GST revenues.

    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 government's plan to recapitalize public sector bank by Rs 2.11 trillion, will aid these banks to make provisions for bad loans, lend money to the corporate and retail sector and would help them in maintaining their Capital Adequacy Ratio (CAR) above the statutory minimum.
  • In FY17, the private sector banks continued to perform better than the public sector banks. The banking sector continued to report high slippages on account of farm loan waivers and default in their corporate loan portfolio.

    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.
  • The ownership in the banking sector remained predominantly in the public sector despite a gradual decline in their share.
  • After a last interest rate cut in August 2017, the Reserve Bank of India (RBI) has maintained a status quo on interest rates. The repo rate in February 2018 stood at 6%. Given the increasing inflation, it is highly unlikely that the RBI reduces interest rates from hereon.
  • The repo rates stand at 6%. 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.

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 '17

  • The domestic economy growth remained muted, the growth in the Indian banking sector too remained under pressure in FY17 as well. Credit growth at 4.7% in FY17 was one of the lowest in over a decade. 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.
  • As at the end of March-2017, 12.1% of the advances of the banking system were stressed. Public sector banks witnessed most of the deterioration in the asset quality as the gross NPA increased to 13.9%. While, that of private sector banks stood at 5.24%.
  • The net interest margin (NIM) witnessed decline during the year due to loss of interest from standard assets slipping into NPAs. The margins reduced to 2.35% in FY17 as compared to 2.42% in FY16.

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Prospects

  • The Indian economy is moving towards normalcy after demonetization and goods and service tax. 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 new RBI directive states that once a default has occurred, the bank will have 180 days within which it should come up with a resolution plan. Should they fail, they will need to refer the account to Insolvency and Bankruptcy Code (IBC) within fifteen days.

    Once an account is referred to IBC, a provision of 50% needs to be made in the books of accounts. Earlier, banks used to delay the recognition of such high provisions by restructuring the accounts in schemes such as Corporate Debt Restructuring (CDR), Scheme for Sustainable Structuring of Stressed Assets (S4A) etc. These schemes have now been scrapped wherein the banks accounted for just 15% provisions. Hence, the profitability of the banks could come under pressure going forward as the accounts are referred to IBC.
  • The government’s plan to recapitalize public sector bank by Rs 2.11 trillion, will aid these banks to make provisions for bad loans, lend money to the corporate and retail sector and would help them in maintaining their Capital Adequacy Ratio (CAR) above the statutory minimum.
  • As the corporate earnings recover in FY18, capacity utilization levels would inch higher and the private capital expenditure cycle could pick up going ahead. This could lead to a spurt in the corporate lending by the banks.

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