Muted corporate loan demand impacts banks

The fear of bad loans and limited lending opportunities to top companies have prompted several banks to shift focus towards the retail (individual loans) and small & medium enterprises segments

India Inc's reluctance to borrow money is keeping bankers worried. While lenders were able to stem fresh impairment in their credit quality in the July-September period, low demand for corporate loans has decelerated the growth in banks' interest income, restricting improvement in their profitability.

The fear of bad loans and limited lending opportunities to top companies have prompted several banks to shift focus towards the retail (individual loans) and small & medium enterprises segments. However, analysts believe this shift in strategy is not working well for many.

M B Mahesh, analyst with Kotak Securities, said in a note to clients on Monday: "We believe this is likely to be the biggest source of concern in 2014-15, as fresh sanctions have not shown improvements, repayments are increasing from existing loans and retail - where banks have shifted focus - contributes to only 20 per cent of overall loans."

The year-on-year growth in non-food credit moderated to 11.2 per cent (its lowest level since June 2001) at the end of this financial year's second quarter. Bankers say companies are increasingly raising money through alternative sources such as commercial paper. Finance from other non-bank sources such as foreign direct investment and external commercial borrowing has also risen.

The slowing in credit growth is more pronounced in state-run banks. Analysts feel this trend is likely to continue in the coming quarters.

With banks unwilling to pare lending rates despite low demand, the net interest margin has remained stable for most lenders. However, analysts fear the margin could weaken in the coming quarters, as bargaining power is expected to remain in favour of borrowers. Also, on the retail side, the bulk of the growth is coming from housing loans, where yields are low.

Credit quality has remained stable, with the economy showing signs of recovery and lenders turning cautious in offering fresh advances. Retail asset quality was firm and improved further with normalcy returning in banks' commercial vehicle finance book.

Analysts, however, warn that there are still reasons to remain cautious on impairment ratios and a sustainable improvement in asset quality might not happen soon.

Manish Chowdhary, analyst with IDFC Securities, noted in his second quarter earnings review report: "Asset quality was mixed - slippages were slightly lower but restructurings were higher. Credit costs were higher than our expectations and there were signs that stress would persist in the near term, as total stressed assets continued to increase."

A few experts felt non-interest income would continue to lead banks earnings growth in the near term. With yields showing a softening bias, many expect the contribution from treasury operations to increase from current levels. Also, retail fees have shown an improvement, aided by pick-up in third-party distribution income. "Improvement in fee income growth could be a key earnings support in the medium term if the trend sustains," Chowdhary said.

Also, said analysts, after the recent rally in the local share market, bank stocks' valuation appears expensive. "Given the strong price run-up, we see moderate risk-reward in the near term...Our price targets also now imply a lower upside of five to 15 per cent, based on the March 2016 book," Nitin Kumar, analyst with Prabhudas Lilladher, said in its report on private banks earlier this month.

He expects the positive influence of improving macro economic drivers (such as lending rates and inflation) on banking stocks to be visible only over the medium term.