From bond yields to new accounting norms, banks face multiple headwinds

A lot has gone in favour of the banking stocks despite the sector reeling under the pressure of bad loans, especially since mid-2015. Notwithstanding this, the CNX Nifty Bank index has been on an uptrend all though this turbulence, gaining 43 per cent as compared to the Nifty and the Sensex, which posted a 28-29 per cent return. But will this party last in 2018? The index, so far, has had a muted start and much of it depends on how the earnings pan out for the year.

The earnings season, which kick-starts this week, will be closely monitored to assess how some of the likely headwinds pan out. These are unfavourable bond yields, adoption of new accounting norms and more importantly the possible hit to earnings in provisioning costs as more cases are referred for resolution under the Insolvency and Bankruptcy Code (IBC). Analysts at Edelweiss Securities note that the liquidity scenario is transitioning from excess to normalisation and yields are likely to stay elevated. Banks, too, have started raising bulk deposit rates. 

“Although we don’t expect any rate action by the Reserve Bank of India in its upcoming monetary policy, in case the apex bank puts forth a hawkish stance, we may see further rise in yields,” the analysts note. 

This could impact the operating profits and subsequently net interest margin, especially of public sector banks (PSBs) by 10-20 per cent, due to a hit on investment portfolios.

Likewise, while the exact impact of adoption of new accounting standards for banks from April 1, 2018, is not known yet, analysts at ICICI Securities state that the first migration on an average translates into a 30 per cent increase in provisioning requirements of the credit portfolio. According to the new norms, banks will have to recognise on expected credit-loss basis as against the current practice of incurred credit loss, though it may only have a one-time impact on banks. Even as the Street has factored in much of the pain under the first list of cases referred for resolution under IBC, the probable impact of the second list of accounts estimated at Rs 1,400 billion will be known in the coming quarters. 

Analysts at JM Financial indicate that gross non-performing assets (NPAs) could increase in the next 12 months, though the pace of increase should be substantially lower than in the past. 

“Only three private sector banks have positive provisioning gap and almost entire universe of PSBs run provisioning deficit of between 10-25 per cent,” the analysts add. Therefore, a lot depends on how the loan growth firms up for the banking system in 2018. 

Working capital loans and loans to small businesses, apart from healthy retail loans and a possible revival in capital expansion is expected to help banks this year.  Whether this will be able to offset the headwinds mentioned earlier will be known in the following quarters.