Tightrope over crisis

RBI measures put more stress on banks

The Reserve Bank of India's (RBI's) "quantitative tightening" has put additional pressure on a banking sector that is already struggling to cope with recessionary conditions. The financial position of banks has seen deterioration over the last two fiscal years. Return on assets for public sector banks dropped to 0.73 per cent in 2012-13 as against 0.88 per cent in 2011-12. Return on assets was down to 1.49 per cent for private banks in 2012-13 versus 1.53 per cent in 2011-12. Deposits grew faster than credit offtake for much of the recent past, indicating low demand. At the same time, non-performing assets are rising, and higher provisioning for NPAs has impacted bottom lines.

The sector has also seen a sell-off. The Bank Nifty is down 14 per cent since the RBI started tightening in mid-July and it is down by over 20 per cent since January 2013. Lower valuations will impede efforts to raise the capital banks need to fulfil Basel III norms. There is also a major dichotomy in the valuations of private sector banks and public sector banks. The latter, which are responsible for over 70 per cent of credit, have weaker balance sheets with poorer asset quality and this is reflected in much lower price-to-earnings ratios. Private sector banks are in relatively good shape. The credit squeeze has effectively pushed up financing cost, the last thing a commercial banker wants in a recession. Bond yields have climbed over 300 basis points since the RBI tightened liquidity. The three treasury auctions, held after the tightening, have all devolved. Primary dealers, mostly banks, have been forced to pick up government paper.

The RBI has estimated that as of March 2012-13 net NPAs amounted to two per cent of assets for public sector banks, and about 0.5 per cent of assets for private sector banks. Restructured loans crossed the Rs 2.5 lakh crore mark by June 2013, with over Rs 20,000 crore restructured in April-June 2013, versus around Rs 15,000 crore restructured in Jan-March 2013. This is close to five per cent of gross advances. Crisil estimates that net NPAs will increase by another 0.7 per cent of advances by the end of 2013-14. The rating agency also estimates that up to 30 per cent of all repayments due in this fiscal year will have to be refinanced. Clearly, that will be difficult. The non-food credit-to-deposit ratio is high, at above 72 per cent, which doesn't leave much room for incremental credit, given statutory liquidity requirements and priority sector commitments.

The RBI's liquidity stance is a poor response to a flawed need to defend the rupee. But it could prove to be very strong medicine for the banking sector. On the one hand, lack of liquidity would prevent ever-greening of sticky assets and this should flush NPAs out of the system. On the other hand, the tightening would make it very difficult to support any resurgence in credit demand and that is bound to adversely impact growth. And, of course, a combination of low liquidity and falling equity valuations makes recapitalisation almost impossible in the short term. Every bank will have to contend with higher rates, sluggish credit growth and dodgy asset quality; but public sector banks will be especially stressed given their much higher exposure to bad loans. As elections loom, public sector banks are also likely to be under political pressure to relax repayment obligations for loans to farmers. The RBI will have to walk a tightrope to ensure that the sector doesn't slip into crisis while the central bank tries to shore up the currency.