Ever since the Asset Quality Review (AQR) mandates have hit the Indian banking space, there has been a persistent pressure on the monetary health of the economy. This has been especially true in the current circumstances, when a revitalized economy is stifled of cash.

With the languishing capital as well as money markets, the economy has found refuge in bank credit, which is expanding at an unprecedented rate of 15% (as on December 2018). Perhaps, not much of a good news since the rate of deposit growth is less than 9%. This comparative difference is creating immense pressure on systemic liquidity, measured by a now very volatile weighted call money rate (Indian LIBOR), which is often higher than the Repo itself.

What this basically means is that banks are feeling the liquidity jitters as they are the only ones with money at the moment. Subsequently, the credit to deposit ratio is now fast approaching the psychological 80 level – a threshold that has never been breached before and can therefore be considered an all-time high figure.

Even NBFCs, which were taking over a lot of unmet demand for capital have been hit hard due to market conditions and unwilling/ unable Schedule Commercial Banks (SCBs) and have seen their market share adversely impacted. Given these circumstances, the SCBs are once again at the forefront and the ‘Report on Trend and Progress of Banking in India’ attempts to see the evolution of this very important component of the Indian economy. In this Impact Analysis, we assess the operations of the banks and study their ability to sustain expectations that rest on their shoulders.   

Borrowings: Money at Call & Short Notice Balances declined by (-) 19.3% in FY18 leading to borrowing duration profile going downhill

Starting with a bird’s eye view, the balance sheet of SCBs expanded by 7.6% in FY18 and stood at Rs. 152,533 billion; the growth remained similar to that recorded in the previous year. Under liabilities, while deposits grew by just 6.1% (as compared to over 10% in FY17), what surprised was the expansion in Borrowings.

The head saw a growth of 31.4% and was primarily driven by Foreign Banks (FBs). While most of the money under this head is borrowed from the RBI under the Liquidity Adjustment Facility (LAF) and is used to bolster capital positions, FBs may have borrowed from home bases, where interest rates are much lower. Total borrowings of all SCBs collectively stood at Rs. 16,823 billion as on FY18. Individually, FBs recorded a maximum growth of 81% and PSBs recording the minimum growth of just over 17% in the classification. Incidentally, the share of borrowing to total liabilities of FBs has now reached almost 15%, a distinction that they now share with PVBs.  

The maturity profile of most of these borrowings mirrored the market preferences as durations went downhill. Borrowings with duration of ‘up to 3 years’ now comprise 73.2% of the portfolio as compared to 64.9%, previous year. This also means that banks want borrowings to support their short term requirements and maybe compensating the decline in ‘Money at Call & Short Notice Balances’, which declined by (-) 19.3% in FY18. Here again, the FBs have almost 96.3% of their portfolio in short term duration with that of Private Banks (PVBs) being more evenly distributed. PSBs do show increased tendency to play in the short term of the curve as per the data. The situation has resulted in a continued asset liability mismatch in up to 1-year category, which needs addressing.

Investments:At Rs. 72 billion, the Held to Maturity (HTM) portfolio has increased almost 2.5 times in FY18

Investment on the other hand, grew by 13% as compared to under 9.8%, the previous year. However, the maturity profile remained pretty much constant with very little variance. We reckon that since most of the investments are in long duration Government securities, which are considered safe haven in volatile times - helps keep the status quo. At Rs. 72 billion, the Held to Maturity (HTM) portfolio has increased almost 2.5 times in FY18 – explaining bank tendencies clearly, strengthening their High Quality Liquid Assets (HQLA) profile.             

Loans & Advances: PSB share in total credit outstanding has fallen below the 70% mark for the first time in Indian banking history

Further assessing the asset side, the Loans and Advances category recorded an expansion of 7.8% as compared to under 3% growth, the previous year. The duration profile has been more or less consistent with the previous year however preference for longer term loans (over 3 years) is seen in both PSBs and PVBs. With an offtake of nearly 20%, PVBs have been consistently leading the pack compensating for both PSBs and FBs. Interestingly, PSB share in total credit outstanding has fallen below the 70% mark for the first time in Indian banking history with private banks consistently gaining market share, which is currently pegged at around ~30%. In fact, nearly 80% of the total credit flows in FY18 came from PVBs.

The Income Statement hasn’t come as a surprise either, given the above factors. A de-growth in interest expended helped Net Interest Income (NII) to actually rise by 7.5%, pegged at Rs. 3,685 billion; the Net Interest Margin (NIM) remained stable at 2.5% as strong offtake shored up assets. Interest income grew by 1% while operational expenses grew by 9.3%, primarily due to higher expenditure on manpower. Provisions and Contingencies was another category which expanded by 33.3% due to the AQR and subsequent Prompt Corrective Action (PCA) requirements. Overall, SCBs recorded a collective loss of (-) Rs. 324 billion in FY18 as compared to a profit of Rs. 439 billion, the previous year. Having said that, the impact of provisioning and other expenses was highest for PSBs as the category was responsible for the overall recorded losses. 

Profit Metrics: PSBs managed to get lower Returns on Advances as compared to other categories – with the difference being almost 120 bps with that of PVBs            

Since overall, the banking sector was running losses, the impact on Return on Assets (RoA) and Return on Equity (RoE) was also significant. Both these metrics recorded (-) 0.2 and (-) 2.8 respectively and augur sustained pressures on bank balance sheets. However, the PSBs were again to be blamed for the debacle as only this category recorded negative ratios; the other two, namely PVBs and FBs continued to have healthier metrics, albeit lower as compared to the previous year.

Overall Spreads, which are the difference between Return on Funds (RoF) and Cost of Funds (CoF) are recorded at 2.8, similar to that of the previous year. All banking categories remained consistent with previous year’s number in this metric. The spreads of PVBs and FBs remained higher than those of PSBs primarily not because of any kind of inefficiencies. Rather, it was a result of comparatively higher Cost of Deposits for PSBs, which stands at 5.1% as compared to PVBs with 4.9% and 3.8% for FBs. Also PSBs managed to get lower Returns on Advances as compared to other categories – with the difference being almost 120 bps with that of PVBs.

Capital Adequacy & Leverage: Leverage Ratio for PVB and FB has gone up substantially over the quarters and has breached the 9% threshold, PSBs on the other hand record it at sub 4%

Capital to Risk Weighted Asset Ratio (CRAR) in the overall banking sector actually improved thanks to higher capital funds raised by PVBs and FBs, which are also more leveraged as compared to their PSB counterparts. Leverage Ratio for PVB and FB has gone up substantially over the quarters and has breached the 9% threshold, PSBs on the other hand record it at sub 4%.

Falling retained earnings have however made sure that PSBs end up with eroded Tier 1 Capital, which has fallen from Rs. 5,480 billion to Rs. 5,270 billion in FY18. The Government of India’s recapitalization plan aims to strengthen this metric in the current and next financial years. Overall, at 13.8%, Tier 1 & 2 capital for all banking categories have been recorded beyond the BASAL 3 mandate of 12.5%.   

Apparent from the mentioned details it is therefore apparent that the banks are under stress and that in turn is impacting their performance and mandates towards the economy. While it is clear that rising offtake signifies that the SCBs are not shying away from their responsibilities and are pitching in with their resources when other sources have become unviable, the sustainability of it all remains questionable, given the current stress levels.

The Gross NPA level, about which we will talk about in detail in the next report has risen to 11.2% and so has been the contribution of SMA 2 accounts, which signals substantial systemic stresses. With the 11 PSBs, that have come under the Prompt Corrective Action (PCA) mandates, the RBI has taken out a major part of India’s financier group, increasing demands on the ones remaining - making risk less distributed. The provision costs, s mentioned have gone up and are eating into bank profits for the most part.

All in all, given the fact that the economy will continue to expand by over 7% for at least two more decades, we must keep in mind that the demand for credit will be relentless. If asset quality ceases to improve, India’s growth potential may actually be compromised.