Beyond the easy money

The first crop of bank results for 2003-04 has justified the recent uptrend in bank stock prices.

The results of some of the bigger banks are yet to be announced but it is likely that they will display the same trend as the smaller banks. Greatly improved results by the smaller banks, among which are some that have so far been considered weak, are important in themselves as they are vulnerable to shocks because of their size. The improvement has been foremost in the banks' non-performing asset (NPA) ratios.

For most, this has come down to below 2 per cent "" the benchmark for healthy operations. The most dramatic improvement in the net NPA ratio (NPA to net advances) has taken place in the case of Indian Bank (from 6.15 per cent to 2.71 per cent) and Allahabad Bank (from 5 per cent to 2.37 per cent).

The fall in the NPA net ratio has been accompanied by sharp jumps in net profit. For Vijaya Bank this has gone up by 109 per cent and for Allahabad Bank by 179 per cent. The gross margins have obviously been enough for the banks to make adequate provisions for NPAs and still be left with a handsome bottom line.

As is to be expected, a key contributor to these results is the trading profits that banks have raked in during a period of falling interest rates.

Margins have also been bolstered by the increase in the net interest margin, the difference between the interest banks earn from their loans and what they pay to depositors. While bank managements have certainly been cleaning up their balance sheets, they have been helped hugely by the buoyant conditions in the economy and in the manufacturing sector.

When the economy and industry do well, the quality of loan accounts improves. This is one reason why the NPAs have shrunk, because better demand conditions for companies have led to improved cash flows "" as in the once troubled but now booming steel industry.

Good and creditable as all this is, it is also fortuitous, and so there is no reason to think that the banking industry is out of the wood. The key test is likely to come in the current year when interest rates have stabilised and banks cannot expect windfall trading gains.

In this regard, UTI Bank has turned in a notable performance without much help from trading profits. The RBI has also to decide when it has done enough to bolster the profits of banks and turn to the interests of depositors and savers.

Interest rates paid by banks have fallen more than what they charge on loans, and the lending rates are high at current inflation levels. Banks therefore need to reduce spreads, and cut costs in order to afford this.

A proper attack on costs and productivity cannot really come unless consolidation is allowed to take place. Thus, while it has been good going for banks so far, they have some way to go.