Banks' profitability likely to come under pressure

The banking sector is expected to face headwinds from rising provisioning requirements, lower treasury gains and pressure on margins

On Wednesday, the Reserve Bank of India proposed – in a draft circular – that banks have to make provisions on the unhedged currency exposure of a corporate borrower. Unhedged foreign currency exposures of corporate borrowers is an area of concern for the regulator in the wake of the sharp depreciation of the rupee. Unhedged foreign currency exposures can result in significant losses to companies due to exchange rate movements. These losses may reduce their capacity to service the loans taken from banks and thereby affect the health of the banking system.

In several interactions with the bankers, the RBI had indicated that merely 40-50% of corporate’s exposure are hedged. Large banks are likely to be impacted the most if the proposal is implemented. RBI has suggested additional standard provisioning of 20 basis points to 80 basis points depending on the unhedged portion.

“We believe the initial impact would be mainly on larger banks (public sector banks like SBI, BoB, BoI and PNB and private banks like ICICI Bank, Axis Bank and HDFC Bank) as they are actively involved in lending through foreign currency, especially long-term loans,” Kotak Securities said in a note to its clients.

A report by Emkay Global estimates an impact of 3-6 basis points on the return on assets (RoA) for public sector banks while the same for private banks would be lesser.

Banks are facing higher provisioning on restructured advances also with the central bank implementing the Mahapatra committee recommendation. From June 1, fresh restructured standard assets will attract provisioning requirement of 5%, as compared to 2.75% earlier. The full impact of the increase in provisioning will be felt in September quarter. Also, for existing restructured assets portfolio, the provisioning has to be gradually raised to 5% by March 2016.

There is some pressure building up on the treasury front also as yields on government bonds have started hardening on expectation that the RBI will hold the key rate again in the first quarter review of monetary policy scheduled end of July. This should also reflect in the treasury income of banks in the September quarter. The rate cut hope was dashed following the sharp depreciation of the rupee which is the worst performing Asian currency since April. A fall in rupee impacts inflation and inflationary expectation adversely since the country heavily depends on crude oil imports.

Net interest margins of the banks is also likely to see some pressure in this quarter as banks will start cutting interest rates on loans or their base rates. However, since deposit growth is sluggish it may not be possible for banks to cut the deposit rates and even if some rates are revised, it will be only for new depositors. A change in the base rate cut impacts both existing and new borrowers.

On the whole, since public sector banks have higher share of restructured assets the impact for them will be higher as compared to private sector banks.