Profitability of banks may come under pressure
The banking sector reported a robust set of numbers in the quarter ended December 31, 2010, led by a 23% year-on-year growth in loans. Contrary to expectations, most banks reported high margins and profit growth. However, an encore appears unlikely given high inflation and the fall out of it — high interest rates.
DEC’10 QUARTER PERFORMANCE : The top six banks by market capitalisation averaged a profit growth of 27% for the quarter ended December 2010. This was on the back of a 31% average growth in net interest income, the measure of difference between interest earned and interest expended by the bank. Due to a simultaneous increase in the rate at which banks borrow from the Reserve Bank of India (the repo rate) and deposit rates amid the tight liquidity situation, banks were expected to report a sequential drop in their net interest margin. Instead, most banks either maintained or expanded their net margins which are the difference between borrowing and lending costs.
The top six banks averaged NIMs of 3.6%, 10 basis points higher on a sequential basis. This was because most of the rise in the interest cost was passed on to borrowers. This, however, may not be possible in the future, as banks cannot pass through higher borrowing costs consistently. Lenders having a high exposure to interest sensitive sectors, such as home loan and car loans, hence could find it difficult to expand their loan book at a fast pace without compromising on margins.
While private sector banks reported a better asset quality, a few state-run banks saw their asset quality deteriorating. Net non-performing assets (NPA) of the top three private banks averaged 0.6% compared to 1.1% a year ago. However, both Bank of Baroda and Punjab National Bank reported higher net NPAs compared to a year ago. There could also be negative surprises in asset quality in the fourth quarter from state-run banks as they shift to a centrally-recognised NPA recognition system.
THE BUDGET IMPACT: The Budget had some positive news for the sector. State-run banks will benefit from the proposed capital infusion of Rs 6,000 crore as this will help banks achieve sustainable growth without getting stretched for capital. The ticket size for housing loans for the priority sector being raised to Rs 25 lakh is also positive for banks such as ICICI and HDFC Bank for whom home loans form a significant part of their overall loans. A lower than expected government borrowing of Rs 3.43 lakh crore will ease yields thereby creating opportunities for banks to make treasury gains. However, a higher farm lending target of Rs 4.75 crore will put pressure on banks particularly the state-run banks. Interest subvention on such lending will lead to delayed cash flows, thus impacting them negatively.
CONCERNS AHEAD : For banks, there are a few worry lines. First, the conflicts in Gulf countries, such as Libya, which have led to spiralling crude oil prices. Combined with higher commodity prices, this could stoke higher inflation. This, in turn, could force RBI to further raise interest rates to cool inflation. Banks could see their margins being squeezed further if interest rates rise at a faster clip.
Another concern is the high credit-to-deposit (CD) ratios of banks. Banks’ incremental CD ratio or the proportion of loans lent from deposits taken was in excess of 100% at the end of December 2010. This could create an asset liability mismatch for banks as short-term money is being used to lend for long-term projects.
The banking regulator has indicated that it would take stricter steps against those banks reporting abnormally high CD ratios. The implications of this are two-fold. One, they need to mobilise deposits at a faster pace and this can be achieved by raising fixed deposit rates. But this will raise the overall cost of borrowing. The other option is to settle for a modest loan book growth, which could result in low revenue growth.
Finally, if the government fails to stick to its targeted borrowings, it could lead to a higher fiscal deficit, signalling higher yields on bonds. In such a scenario, banks would see their profits erode due to mark-tomarket losses.
Processing your request, Please wait....
