Banking sector's asset woes to continue in FY14

Higher provisioning from FY14, slower deposit accretion will impact margins

If consensus estimates are to be believed, the markets are headed for a cyclical uptick in FY14, driven by rate cuts. With economic growth bottoming out and corporate profitability stabilising, it would be fair to assume the banking system would be a beneficiary of this trend. Banking analysts, however, don't expect this to happen, the recent rate cut notwithstanding. So, even if public sector banks look attractive, it could be a "valuations trap", rather than a "value buy". There are several reasons behind the negative stance the market has on the banking sector, especially public sector banks.

From FY14, banks will have to hike provisions for incremental bad loans from the existing 2.75 per cent to five per cent. This will lead to a rush to restructure stressed assets, Ambit's analysts believe. "Such enhanced provisioning could potentially impact system return on assets by 15-20 basis points," they add. A significant portion of loans to thermal power projects is expected to turn into non-performing loans or come up for restructuring, analysts believe. Realising the nature of the problem (lack of fuel availability), the regulatory authorities have given concessions on classification of stress in the infrastructure space. The pain in the power sector will impact not just PSBs, which have on-balance sheet exposure to the sector, but also private sector banks (which have off-balance sheet exposure to the sector).

Rate cuts, therefore, will not have any major impact on asset quality issues, as it won't ease pain for the seriously stressed. At present, bad and restructured loans account for a little more than 10 per cent of total system advances, believe analysts. This will impact the earnings of banks over the next 24 months, say experts. Higher provisioning and strict norms on recognition of bad loans will also impact profitability.

It's not merely the issue of bad loan accretion and the consequent impact on profitability. Thanks to the penetration of private sector banks, the funding franchise of PSBs has also come down over the last few years. PSBs had 78 per cent share in the low-cost current account and savings account deposits in FY02, down to 64 per cent in FY12. This, coupled with weak deposit growth, could put pressure on the margins of banks, as deposit rates will continue to be high. Given that deposit growth remains slow and liquidity is tight, analysts expect loan growth in FY14 to be closer to 14-16 per cent. IDFC Institutional Securities says: "Stress-adjusted valuations of public sector banks are 40-90 per cent higher than unadjusted valuations and well above historical averages." These factors only contribute to the attractiveness of strong private sector banks like ICICI Bank, HDFC Bank and Axis Bank.