Author
Raghu Mohan is an award-winning senior journalist with 22 years of experience. He has worked for BW Businessworld since December 2006, and is currently its Deputy Editor. His area of expertise is banking – commercial, investment, and the regulatory. Previous stints include those at The Financial Express and Business India.
Raghu Mohan points out that despite a 75 bps cut in the repo rate between January and June 2015, we only saw a 30 bps pass-on by banks A day after the Reserve Bank of India’s (RBI cut the repo rate by 50 basis points (bps) to 6.75 per cent, a clutch of banks went for a trim in their Base Rates (BR) – it ranges between 25 bps and 40 basis. The sharpest were by the State Bank of India and Punjab National Bank (both by 40 bps) to 9.3 per cent and 9.60 per cent. A reduction in bank BRs after Mint Road’s repo rate cut at first glance seems to suggest that the “transmission effect” is now in full play; that the clogs have been removed. After all, between the last policy and the just announced one, bank BRs (as presented in RBI’s Weekly Statistical Supplement) hardly moved: 9.7-10 per cent from 9.75-10 per cent. At end-March 2015, they were at 10-10.25 per cent levels (the same as in January before the first rate cut). Despite a 75 bps cut in the repo rate between January and June 2015, we only saw a 30 bps pass-on to you and I by banks. Mint Road noted the financial markets have transmitted its past policy actions (lower yields on commercial paper and corporate bonds), but banks had done so only to a limited extent (as in lending rates have been stubborn). So what’s changed now? Let’s flashback to September 1 this year when HDFC Bank cut its BR by 35 bps to 9.35 per cent; peers SBI and ICICI Bank held it at 9.7 per cent then. It was a pre-emptive strike by the bank ahead of the festive season, and it had in any case, been reducing its deposit rates over time – it was logical or it would have hit the bank’s net interest margin (NIM) in a big way. HDFC Bank’s rivals held their BR – perhaps in anticipation of a repo rate cut by RBI. What should not be lost sight here is that they did not feel it worthwhile to let go on the NIM front for market share; or in other words did not feel that HDFC Bank will gain much anyway – given the tepid appetite for credit. M B Mahesh, analyst at Kotak Institutional Equities had said at that point in time that it is not very clear on what the likely response from other banks will be as they need to strike a balance between growth and NIM outcomes. “Given the lack of growth, we ideally would want banks to cut deposit rates a bit more aggressively as lending rate cuts are unlikely to boost credit demand. The broad outcome of a negative NIM outlook for the sector is slowly playing out but we do not see this as an end. We see it getting worse as we see a weak investment cycle ahead. However, aggressive cut in NIM at a time of slow growth does not achieve the desired objective and only results in more capital consumption, which is counter-productive”, he had explained. But as Madan Sabnavis, chief economist at Care Ratings says: “The strange part is that banks are letting go on NIMs by not cutting deposit rates aggressively, but are cutting the BR”. What’s unsaid here is that North Block must have nudged banks cut their BRs. In the hope, it will fire the economy going ahead. What we now have is a situation wherein some bank have decided to take a hit on NIMs (to the extent they have not cut deposit rates). Another way to interpret is that a cut in the BR does not imply they will lend at the publicly declared “rack rate” (there is a mark-up of four per cent over the BR anyway). And there will not be a big hit on NIMs either; that BR cuts (for now) make for great theatre! Now let’s look at at credit offtake numbers. The increase in bank non-food credit during the financial year so far until September 4, 2015 was Rs 1,57,500 crore compared to Rs 1,12,400 crore during the same period last fiscal. As Sabnavis says: “While this does indicate an increase, the number is skewed on account of the sharp increase in the credit in the first fortnight of the new financial year, which is between March 20 (the reporting fortnight for considering bank credit for the year) and April 3rd. During this fortnight, the increase in credit was Rs 2,91,500 crore (Rs 79,400 crore), with a large part attributable to the loans taken in the context of the spectrum sale. “Since then, incremental credit has been in the negative zone”, he adds. It also need to borne in mind that this abysmal credit numbers above had nothing to do with high interest rates. It had more to do with the general downturn in the economy and the overhand of bad-loans on bank books. RBI’s Report on the Trend and Progress of Banking (2013-14; the latest) explained that the consolidated balance sheet of banks in 2013-14 registered a decline in growth in total assets and credit for the fourth consecutive year. “This decline could be attributed to a variety of factors ranging from slower economic growth, de-leveraging, and persistent pressure on asset quality leading to increased risk aversion among banks and also increasing recourse by corporates to non-bank financing including commercial papers and external commercial borrowings. With both credit and deposit growth more or less same, the outstanding credit to deposit (CD) ratio at the aggregate level remained unchanged at around 79 per cent”. The Report did cite high interest rates for this sorry state of affairs! It is also unlikely that a mere reduction in interest rates will lead to a spurt in economic activity. Just a few days ahead of Mint Road’s policy meet, India Ratings and Research told us that the capex cycle of the top 500 asset owning corporates (excluding banks and financial services) may be close to bottoming out, but qualified it. “While further downside to capex spending is limited, an immediate meaningful revival of private capex spending is unlikely. Factors such as subdued commodity prices and capacity utilisation levels close to decade lows provide limited motivation to private corporates to take up capex. The high leverage of a large number of corporates may limit their ability to take up even normal maintenance capex”, said Ashoo Mishra, Associate Director at India Ratings.
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Banks will find it tough to pass on RBI rate cuts, argues Raghu Mohan At long last, the Reserve Bank of India (RBI) has obliged with a repo rate cut of 50 basis points (bps) to 6.75 per cent -- a four-and-half-year low. It left the cash reserve ratio or CRR (the proportion of deposits banks’ park with Mint Road) and the statutory liquidity ratio or SLR (the proportion of deposits to be invested in government securities) unchanged at four per cent and 21.5 per cent, respectively. Will you and I get to borrow cheap from here on? Will India Inc., go the whole hog and invest big time? Unlikely. Just read this line from RBI governor’s Raghuram Rajan’s policy text: “While the Reserve Bank’s stance will continue to be accommodative, the focus of monetary action for the near term will shift to working with the Government to ensure that impediments to banks passing on the bulk of the cumulative 125 bps points cut in the policy rate are removed”. The reference to a 125 bps cut is to those in the calendar plus today’s 50 bps. And what exactly are the impediments? What’s The Context Here…That Mint Road has gone in for a deep 50 bps cut in the repo rate – the price at which banks borrow funds from RBI – is a clear indication of the quagmire we are in. Let’s also get this clear: a repo rate cut does not lead to an infusion of funds into the banking system unlike a cut in the CRR or SLR (to the extent that banks have to invest less in government paper). On the latter, you also need to remember that given the times we are in, banks have taken the option to invest more under SLR. The RBI’s Annual Report for 2014-15 says banks continue to hold around 28 per cent by way of SLR despite a slash in it over time to 21.5 per cent (from 23 per cent). Mint Road’s reasons: “… the buffer providing access to collateralised borrowings from the wholesale funding market and the Reserve Bank. Maintaining excess SLR securities also helped banks to weather the impact of the current slow phase of the economic cycle on their balance sheets and earnings”. That’s why a 75 bps cut in the repo rate between January and June 2015 saw only 30 bps pass-on to you and I by banks. Lower bond yields mislead. Mint Road captures this reality when it notes that the financial markets have transmitted it’s past policy actions (lower yields on commercial paper and corporate bonds), but banks have done so only to a limited extent (as in lending rates have been stubborn). On Tuesday, the point was repeated: “The median base lending rates of banks have fallen by only about 30 bps despite extremely easy liquidity conditions. This is a fraction of the 75 bps of the policy rate reduction… even after a passage of eight months since the first rate action by the Reserve Bank. Banks’ deposit rates have, however, been reduced significantly, suggesting that further transmission is possible”, observes RBI. Will Banks’ Oblige From Here On?A month from now, Mint Road will come out with a new base rate (BR) calculation – marginal cost of funds from weighted average cost of funds; RBI intends to implement it from 1 April, 2016. Dhananjay Sinha, Head-Institutional Research at Emkay Global, is of the view that if implemented in its current form, these norms are likely to be negative for banks' NIMs (net interest margins) until the average cost of funds catches up with the marginal cost of funds. Why so? Bank deposits were contracted at a higher rate (only a relatively small portion of it were contracted at a lower rate after and during the cumulative repo rate cuts of 125 bps in the calendar so far; of which 50 bps happened only today). Therefore, a cut in the BR will only mean banks will have less to pocket for themselves. A way out, as Sinha says, is for banks to either increase the spread over the BR or let NIMs get impacted. Of course, in a rising rate environment, the proposed BR regime will work in favour of lenders as banks would pass on higher rates immediately. “Hence, we expect movements in BRs, and hence NIMs, could likely be volatile and frequent, which is likely to make banks' balance sheets more vulnerable to sharp interest rate movements””, adds Sinha. The essence of the above is banks have two options: either let NIMs dip and crib. As Pawan Agrawal, Chief Analytical Officer-CRISIL Ratings noted when RBI came out with its BR draft norms: “Our base-case is that profitability of banks will have a one-time impact of around Rs 20,000 crore in fiscal 2017, which would be equal to 15 per cent of the total estimated profit of the banking system for that year. The actual impact will depend on whether the banks will be given a leeway to make this shift over a longer timeframe in the final guidelines.” Agrawal says returns of banks that lend mostly on a floating rate basis will be significantly impacted in an environment of falling interest rates – as floating rate is pitched over the BR. As the BR falls (and along with it the floating rate), so will the interest income of banks. And that banks with low levels of current and saving accounts, or relatively longer tenure-term deposits, will also be majorly affected. That’s because their cost of funds will not come down soon enough -- as they will continue to pay interest to depositors at the old rate (before a policy rate cut). Or banks up the spread over the BR itself (which they are legally allowed to have anyway). If this happens, you will see a peculiar situation. Banks will publicly state they have dropped their BRs – not in proportion to the current repo rate cut, but a cut by a small margin – but when you actually go to borrow, the rate will more or less be at what they were before the current repo rate cut. Lower lending rates will be an illusion – that’s what most likely to happen anyway. What’s not to be lost sight here is that liquidity has not been issue at all; it sloshes about, but there have no takers for it at the banks’ credit window. Mint Road’s inter-bank money market numbers are reflective of the deeper rot in the economy. Liquidity conditions eased considerably during August to mid-September. Sure, in addition to structural factors such as deposit mobilisation in excess of credit flow, there was lower currency demand and pick-up in spending by the government which contributed to the surplus liquidity. The point is that the average net daily liquidity absorption by RBI (or what banks gave to the RBI) went up from Rs 12,000 crore in July to Rs 26,000 crore in August and to Rs 54,400 in September (up to September 15). Money market rates generally remained below the repo rate. It changed subsequently (as in RBI injected money), but that’s due to technical reasons -- quarterly tax collections went out of the system from mid-September, deficit conditions returned and the Reserve Bank engaged in average net injections of the order of Rs 54,400 crore (September 16th to 27th) which kept call rates close to the repo rate. Governor Rajan has pleased all and sundry with a repo rate cut – the shrill cries for it will taper off for a while now. The “focus of monetary action for the near term will shift to working with the Government to ensure that impediments to banks passing on the bulk of the cumulative 125 bps points cut in the policy rate are removed”. Let’s see how that part pans out!
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The Centre and Mint Road wants to ensure that India Inc is not starved of funds – who know what happens after a Fed Rate hike. Raghu Mohan explainsIn a bid to widen the pool of capital sources for India Inc to drink from, the Reserve Bank of India (RBI) is to weigh the option to allow firms to borrow from global long-term fund dispensers. In its draft framework for external commercial borrowings (ECBs), Mint Road said India Inc can tap pension funds, sovereign wealth funds (SWFs) and insurance funds as part of a revised ECB policy which is on the anvil. The draft paper (which has been placed for feedback till October 1) on ECBs also proposes to lower the all-in cost borrowing by 0.50 per cent (50 basis points) to ensure funds borrowed from abroad are at a reasonable interest rate. Raghu MohanIn effect what it means is that India Inc (to the extent it can borrow liberally from SWFs and pension funds) will able to hook into long-term sources of capital. It is worth to recall here what RBI deputy governor S S Mundra, explained at a summit on ‘Financing India’s Growth - Way forward’ in New Delhi on 9th September 2015. He pointed out that traditionally, like other emerging markets, Indian economy has been bank-dominated. So whether it is for project development, or working capital needs of corporates, banks have been the primary source of credit. Though primarily banks are supposed to undertake maturity and liquidity transformations, there are limitations on the extent of asset-liability mismatches they can run on their books. In simple terms what it means is that banks raise short-term deposits between one and three-year’s maturity; and they can’t be expected to finance long-gestation projects (like say in in infrastructure) of 15 years or more. The large scale distress being witnessed in banks’ infrastructure portfolio also raises issues about their ability to critically appraise such projects. The typical role for the banks in mature markets is to originate loans and then distribute to other willing players in the market. They predominantly undertake working capital finance and provide structured financial solutions to their clients. They also act as market makers for various financial sector products. “With the gradual widening and deepening of our financial markets, it would be fair to expect our banks to also gradually shift their focus to SME and retail clients while leaving the long-term resource contribution to other players including pension funds and insurance companies which have long-duration liabilities on their balance sheets”, said Mundra. The urgency shown by (to the extent the feedback deadline is 1 October) shows that the Centre and Mint Road wants to ensure that India Inc is not starved of funds – who know what happens after a Fed Rate hike. Moreover, many a state-run bank is no position to lend too given the precarious nature of their books and pressure on capital ahead of Basel-III capital norms which kick in from fiscal 2019. It’s not a surprise that on Wednesday, Union Economic Affairs Secretary Shaktikanta Das said that “we cannot have the luxury of giving two months’ time for discussion because enough has been said and enough has been heard. Now, the time has come to decide and move forward”. He was speaking at the ‘Global Investors India Forum’ organised by Assocham. Mint Road said that the proposed guidelines are aimed at replacing the ECB policy with “a more rational and liberal framework, keeping in view the evolving domestic as well as global macroeconomic and financial conditions, challenges faced in external sector management and the experience gained so far”. The basic thrust of the revised framework, RBI said, is to retain more qualitative parameters for the normal (foreign currency denominated) ECBs and to provide more liberal dispensation for long-term borrowings in foreign currency. What’s On The AnvilBasic Structure: Retention of the existing basic structure of ECB framework for normal foreign currency borrowings with certain liberalisations made based on experience. The restrictions on eligible borrowers, end-use (capital expenditure), maturity (not less than three to five years) and all-in-cost (linked to a spread over Libor) for such ECBs will continue. Lenders/investors: Expansion of the list of recognised lenders to include entities having long term interest in India. Overseas regulated financial entities, pension funds, insurance funds, sovereign wealth funds and similar other long term investors are included in the list of recognised lenders for long-term funding into India. Long-term foreign currency borrowing: Prescription of only a negative list of end uses for long-term foreign currency borrowings (minimum maturity of 10 years). Rupee denominated borrowings: Prescription of more liberal stipulation for rupee-denominated ECBs with only minimum maturity stipulations. The borrowing can be accessed for all purposes save a small negative list.
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Raghu MohanThe Reserve Bank of India (RBI) has issued “in-principle” approval to ten applicants to set up small finance banks (SFBs) to bolster financial inclusion to cover the vast swathes of the unbanked. The idea is akin to the move to set up local area banks (LABs) in the mid-90s which was an unqualified flop. Will its new avatar work? In the current context where size is everything, it remains to be seen how these SFBs fare. While they are designed to be small, in just about every other aspect of regulation, they are to be seen as your regular bank. Again, operationally, it’s anybody’s guess as to what kind of cost advantage they can have – rentals (office and branches) will be on a par with any other bank; as for salaries, just what kind of talent can they attract if it not aligned with the market? Let us also not lose sight of the fact that some of the bigger state-run and private banks have now started to target (in an aggressive manner) the very same audience that the proposed SFBs aspire to cater to, albeit at the top of this pyramid. On paper, the idea is laudable. It was the Committee on Financial Sector Reforms (Chairman: Dr. Raghuram G. Rajan; 2009) which opined on the need to set them up; that the sufficient change (in the environment) warranted experimentation with well-governed deposit-taking SFBs. And to offset their higher risk from being geographically focussed, it was for higher capital, a strict prohibition on related party transactions, and lower allowable concentration norms. It was seconded by the report on `Banking Structure: The Way Forward’ (27th August 2013). Will It Fire?To flashback. In his “Dream Budget of 1997”, then finance minister P Chidambaram made a case for LABs to provide organised finance for rural India – not very different from SFBs. In August 1997, Mint Road allowed them entry -- Manipal LAB (Manipal; Karnataka); Priyadarshini LAB (Aurangabad, Maharashtra)) and Krishna Bhima Samruddhji LAB (in Karnataka and Andhra Pradesh). Later, an “in-principle” nod was given to five more -- Capital LAB (Nakodar, Punjab); Coastal LAB (Vijayawada, Andhra Pradesh); LAB of Kongunadu Ltd (Salem, Tamil Nadu); Central Gujarat LAB (Dabhoi, Gujarat); and Vinayak LAB (Sikar, Rajasthan). The last time we got a full report on the functioning of these banks was from `The Review Group on The Working of LAB Scheme’ (1st September 2002) under the chairmanship of G Ramachandran (Former Finance Secretary). It was critical; and its major findings were: that in their catchment areas, they had a limited footprint, and they were swamped by commercial banks. The Committee concluded that “we are strongly of the view that whether it is rural banking or any other segment of the financial sector, size, whether in terms of capital base or totality of operations as reflected in the balance sheets, is of critical importance. It is size which inspires and retains the confidence of depositors and borrowers alike. It is size of capital which enables a financial entity to cope with unexpected adverse trends in its business and overcome threats to its survival from any panic reaction on the part of its investors”.
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Merger of weak banks with strong has its downside. Is it worth the pain? Raghu Mohan explores It’s an idea which has been spoken about in the past, and finance minister Arun Jaitely has thrown up the same again -- that the Centre is not averse to merging weaker state-run banks with stronger ones. On Wednesday (9 September), Jaitely said that while steps to shore up the financial strength of state-run banks has been done through capitalisation, “After this (measures) if there is a fragile bank, we are looking at consolidation with stronger banks. So it's not that banks don't get a priority. In fact, after inheriting the banks in a fragile situation, we are systematically trying to address each of these problems”. The reference is to concerns that the weaker among state-run banks may be too fragile to continue to do business in the emerging landscape – that’s even after the steps taken to capitalise them and re-engineer their innards with the “Indradhanush” initiative. The Triggers NowThe number one headache for Jaitely and team is the mess as ariticulated S S Mundra, Deputy Governor-RBI (Indian Banking Sector: Emerging Challenges and Way Forward; 5th May 2015). That while the banking system is adequately capitalised, he saw challenges on the horizon (for some of banks). For the system as a whole, capital adequacy has steadily declined; as at end-March 2015, it stood at 12.70 per cent from 13.01 per cent a year earlier. “Our concerns are larger in respect of state-run banks where it has declined further to 11.24 per cent from 11.40 per cent over the last year”, he said. He went on to add that even the best performing state-run banks have been hesitant to tap the markets to raise their capital levels; that it would be difficult for the weaker to raise resources from the market. “There is a constraint on the owners insofar as meeting the capital needs of these banks and hence, the underperforming banks are faced with the challenge of looking at newer ways of meeting their capital needs. A singular emphasis on profitability ratios (based on RoA and RoE) perhaps fails to capture other aspects of performance of banks and could perhaps encourage a short term profitability-oriented view by bank management”. Mundra made it clear that he did wish to get into the merits of this approach, “but from a regulatory stand point, we feel that some of these poorly managed banks could slide below the minimum regulatory threshold of capital if they don’t get their acts together soon enough.. The need of the hour for all banks, and more specifically, in respect of state-run banks, is that capital must be conserved and utilised as efficiently as possible”, Mundra explained. And given the state of fisc, Jaitely will do well to conserve the Centre’s wallet too; but as to whether it should be done by merging the weak with the strong is a moot point. But let us step back and look at the historical to get a grip on what we are on. Blast From The PastFrom the early days of reforms, banking sector consolidation has been detailed in various reports – M Narasimham Committee -I (1991), S H Khan Committee (1997), M Narasimham Committee-II (1998), S S Tarapore Committee on Fuller Capital Account Convertibility (2006), Raghuram G. Rajan Committee (2009) and the Committee on Financial Sector Assessment (CFSA-2009; chairman Rakesh Mohan who was deputy governor-Reserve Bank of India). In his inaugural address on the annual day of the Competition Commission of India on May 20th 2013, P Chidambaram as finance minister alluded, inter alia, to the need for restructuring of banks through mergers. To quote “ ... some banks, including some public sector banks among the 26 public sector banks that we have, may be better off merging. The need for two or three world-size banks in an economy that is poised to become one among the five largest in the world is rather obvious”. What should not be missed is Chidambaram’s reasoning for this: that we need globally competitive large banks; it was not to “bailout” weak banks! Since 1961 till date, there have been as many as 81 bank mergers out here of which 47 took place before the first phase of nationalisation in July 1969. Out of the remaining 34 mergers, in 26 cases, private sector banks were merged with state-run banks; and in the remaining eight cases, both the banks were private sector banks. The spate of mergers before and immediately after nationalisation is not relevant to the times we live. Let’s come to the post-reform period -- there have been 31 bank mergers. And mergers prior to 1999, (under Section 45 of the Banking Regulation Act, 1949) – and this is the most critical period -- were primarily resorted to in response to the weak financials of the banks being merged. Of this lot, the merger of Global Trust Bank with Oriental Bank of Commerce must find particular mention – that of a basket case new-generation private bank being merged with a state-run bank or of tax payers paying for private loot! Whatever be the colour of capital, the bottomline is there is no reason for a good bank pay to for the sins of a rotten apple. In the post-1999 period, however, business sense led to voluntary mergers between healthy banks under Section 44A of the Act. The merger of New Bank of India with Punjab National Bank (way back in 1993); and the acquisition of State Bank of Saurashtra (2008) and State Bank of Indore (2010) by the State Bank of India are the only instances of consolidation among state-run banks. All involved pain. Bank Mergers The Pros: • Larger banks may be more efficient and profitable than smaller ones and generate economies of scale and scope. Furthermore, the reorganisation of the merged bank can have a positive impact on its managerial efficiency. The efficiency gains may lead to lower cost of providing services and higher quality as the range of products and services provided by larger banks is supposedly wider than what is offered by smaller banks. Experience in some countries indicates cost efficiency could improve if more efficient banks acquire less efficient ones.• Consolidation may facilitate geographical diversification and penetration towards new markets. *• Big banks are usually expected to create standardised mass-market financial products. The merging banks may try and extend marketing reach and enhance their customer-base.• The common criticism against consolidation is that it will have an adverse effect on supply of credit to small businesses, particularly, those which depend on bank credit, as consolidated big banks would deviate from practising relationship banking. But, there is recent evidence that reduced credit supply by the consolidating banks could be offset by increased credit supply by other incumbent banks in the same local market.• The transaction costs and risks associated with financing of small businesses may be high for small banks. Large and consolidated banks can mitigate the costs better and penetrate through lending into these sectors.• One of the arguments cited against consolidation is that it may result in rationalization of branch network and retrenchment of staff. However, rationalisation may lead to closure of branches in over banked centers and opening of new branches in under banked centers where staff can be redeployed. And the Cons:• It can result in neglect of local needs leading to reduction in credit supply to some category of borrowers, particularly small firms. The consolidated bank may rather cater to big ticket business, in the process adversely affecting financial inclusion.• Not all customers are treated in the same way by the big banks. There is empirical evidence that one consequence of the merger wave in US banking in 1990s has been that loan approvals for racial minorities and low income applicants have fallen and the extent of this decline was more severe for large banks.• The consolidating institutions are found to shift their portfolios towards higher risk-return investment.• Consolidation could also result in less competition through structure-conductperformance-hypothesis giving fewer choices to the customer and arbitrary pricing of products.• Empirical evidence suggests that financial consolidation led to higher concentration in countries such as US and Japan, though they continue to have much more competitive banking systems as compared with other countries. However, in several other countries, the process of consolidation led to decline in banking concentration, reflecting increase in competition. Source: RBI Discussion Paper on Banking Structure in India -- The Way Forward (2013). Prepared by the Department of Banking Operations and Development; and Department of Economic Policy and Research. A working group set up by Indian Banks’ Association (IBA;2004) “Consolidation in Indian Banking System: Legal, Regulatory and Other Issues” was of the view that it made sense to bring all banks under the Companies Act so as to ensure that legal dispensation for mergers in banking sector is akin to that of corporate mergers. But it never made a case for a merger between weak and the strong. It can take down both!
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Raghu Mohan says if anything, banks must be complimented for practicing the art of “lazy banking” In early January this year, Prime Minister Narendra Modi made a call to end "lazy banking" on the last day of the bankers' retreat, 'Gyan Sangam'; he asked banks to play a proactive role to help the common man. Noble as these intentions are, for the better part of the year banks were more worried as to when and how much capital would come in from the Centre by way of capital infusion ahead of Basel-III which kicks in from fiscal 2019 -- we are talking about state-run banks which account for 76 per cent of the banking industry’s assets. In August (eight months after Gyan Sangam), we finally got a roadmap on the numbers. That state-run banks -- over a four-year period -- would need Rs 1.80 lakh crore in capital. Of this, these banks would have to tap the bourses to raise Rs 1.10 lakh crore. Financial Services Secretary Hasmukh Adhia said these estimates were based on credit growth rate of 12 per cent for the current year, and 12-15 per cent for next three years which will depend on the size of the bank. The Centre’s share will be Rs 70,000 crore over this period -- of this Rs 25,000 crore each will be infused in 2015-16 and 2016-17 and Rs 10,000 crore each in 2017-18 and 2018-19. Raghu MohanThis assurance is good, but there’s nothing to suggest that more capital will not be sucked in. In the six months since the Gyan Sangam, what’s happened is that the bad-loan situation has worsened. Mint Road’s Financial Stability Report (June 2015) observed that while risks to the banking sector had moderated marginally since September 2014, concerns remain over the continued weakness in asset quality indicated by the rising trend in bank’s stressed advances ratio. Gross non-performing assets (NPA) went up to 4.6 per cent from 4.5 per cent between September 2014 and March 2015. So too restructured standard assets to 11.1 per cent (10.7 per cent). State-run banks recorded the highest level of stressed assets at 13.5 per cent of total advances as of March 2015. You can take relief that the net NPAs of banks remained unchanged at 2.5 per cent during September 2014 and March 2015. The FSR was of the view that the current deterioration may continue for few more quarters; that falling profit margins and debt repayment capabilities of India Inc., add to these concerns though the overall leverage level in Indian economy is comfortable when compared to other jurisdictions. That pain is to going to be around for some time is once again highlighted by Ernst & Young’s (Fraud Investigation & Dispute Services) report on `’Unmasking India’s NPA issues – can the banking sector overcome this phase?’ The report (released today: 8th September) is based on the responses received from over 110 respondents during the period November 2014–March 2015. The principal respondents were bankers from state-run, private, foreign and co-operative banks; they were drawn from vigilance, credit, operations, legal, compliance, asset recovery, audit, and finance departments. And this is what it said. · 72% said that the borrowers are misusing the restructuring norms · Around 86% of the respondents stated that existing monitoring procedures such as internal audits and concurrent audits alone were not enough to verify adequate functioning of the NPA mechanism. This highlighted the need to strengthen internal processes and controls for early detection of issues. · 91% respondents stated that forensic audit must be made mandatory to ascertain the intent of the borrower and further 54% respondents that this would help in weeding out ‘wilful defaulters’ from genuine borrowers and thereby reduce recovery costs/efforts · 44% stated the impact on provisioning or performance of the bank branch is one of the key reasons that are preventing banks from reporting borrowers as ‘wilful defaulters’ · Only 15% of the respondents seemed optimistic and think that NPA numbers will be curbed due to regulatory changes and increase supervision by the Reserve Bank of India (RBI). The RBI recent circular ordering all banks to ensure vigilance during the pre-and-post sanction due diligence processes is expected to prove a step in the right direction. · 86% respondents stressed on the need for an effective mechanism to identify hidden NPAs. Additionally, around 56% stated that used of data analytics and technology can be an efficient enabler to identify any red flags or early warning signals. · 68% of the respondents said that developing internal skill sets on credit assessment/ evaluation are necessary The point here is all of the above information comes from the deep recess of banks – the great watering hole at which all of India Inc., drinks from. What more information do the authorities need? Finance Minister, Arun Jaitley knows only too well what the issues are. On August 21 this year, he made reference to the all-out efforts launched to correct the current "unacceptable" level of bad loans in state-run banks. “NPAs, which have reached to the present level are unacceptable. They reached this level partly because of indiscretion, partly because of inaction, partly because of challenges in some sectors of the economy, which were evident through the high NPA in these sectors," he said. On today’s meet, Arundhati Bhattacharya, chairperson of the State Bank of India said: “we have suggested to the Government to revive stalled projects and make investment climate more conducive and business friendly. We understand that Government is keen on improving conditions for doing business and making efforts in that direction.” You can’t expect the head of a state-run bank to say more than that, but how are to do this when banks’ are not able to lend without a proper policy on NPAs or specific business areas?As for “lazy banking”, look no further than the Reserve Bank of India (RBI) to know why it is so. Despite Mint Road’s slash of the statutory liquidity ratio (SLR) — the percentage of deposits that banks have to invest in government securities (G-Secs) – over time to 21.3 per cent from 23 per cent, banks continue to hold around 28 per cent (by way of SLR). In its Annual Report for 2014-15, Mint Road explains the reasons for the excess holding of SLR by banks: “… the buffer providing access to collateralised borrowings from the wholesale funding market and the Reserve Bank. Maintaining excess SLR securities also helped banks to weather the impact of the current slow phase of the economic cycle on their balance sheets and earnings”. Simply put what it means is that banks held excess by way of SLR – that is, they chose to invest higher amounts in G-Secs — as they could pledge them to raise funds from the money markets; and that at a time of dip in bank’s asset quality, such investments stood them in good stead. If anything, banks must be complimented for practicing this art of “lazy banking” (!). It’s better to do so than lend more monies after bad, and then twiddle your thumb in private despair when it does not return home. The pow-wow today between the prime minister and industrialists, bankers and economists make for great optics; and may help sooth frayed nerves – but the remedial has to be done on the ground.
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The idea behind a new BR based on marginal cost of funds is that it will be more sensitive to policy rate changes, writes Raghu MohanEvery time, the Reserve Bank of India (RBI) cut its key rates, you continued to crib that bank lending rates still held firm. On its part, Mint Road grew tired of banks who peddled the view that their cost of funds had not fallen; it led Governor Raghuram Rajan to quip (6th April 2015) that it was "nonsense" to assume that the cost of funds had not fallen”. In this fiscal’s first bi-monthly policy review, RBI prodded banks to use a modified Base Rate (BR) – the floor rate below which they can’t lend. The new BR “based on the marginal cost of funds should be more sensitive to changes in policy rates. To improve the efficiency of monetary policy transmission, (we) will encourage banks to move in a time-bound manner to marginal cost of funds-based determination of their BR,” RBI had said. The idea behind a new BR based on marginal cost of funds is that it will be more sensitive to policy rate changes. Sure, only the new BR draft guidelines are out, what’s in store? Grin And BearThe first hit will be taken by banks. Says Pawan Agrawal, Chief Analytical Officer-CRISIL Ratings: “Our base-case is that profitability of banks will have a one-time impact of around Rs 20,000 crore in fiscal 2017, which would be equal to 15 per cent of the total estimated profit of the banking system for that year. The actual impact will depend on whether the banks will be given a leeway to make this shift over a longer timeframe in the final guidelines.” Says Parag Jariwala of Religare Institutional Research: “We think this methodology would lead to frequent BR changes. It may not go down well with borrowers, particularly when interest rates are rising. In a declining interest rate scenario too, frequent BR cuts would hurt banks as deposits would be re-priced with a lag”. How The New BR WorksCost of deposits: To be calculated using the latest interest rate payable on CASA (current and saving accounts) deposits and term-deposits. The cost of borrowings is to be arrived at using the average rates at which funds were raised in last one month preceding the date of reviewNegative carry on reserves (CRR and SLR): This would be based on the marginal cost of funds calculated above, implying negative carry will increase or decrease with an increase or decrease in cost of funds (negative carry will decline when deposit rates are cut)Un-allocable Overhead Costs: It is to remain fixed for three years Average Return on Net Worth: This is the hurdle rate of ROE determined by the Board or management of the bank. RBI expects banks to keep this component fairly constant and any change be made only in case of a major shift in business strategy Source: Religare Institutional Research It was from 1st April 2010 that the BR concept kicked in. Until then, it was the benchmark prime-lending rate (BLPR). A large universe of borrowers had their loan priced below it. At that point in time, the RBI pointed that the share of sub-BPLR lending by banks (excluding export credit and small loans) increased to 70.4 per cent in September 2009 from 66.9 per cent in March 2009. Strangely enough, the whole idea underlying the BPLR was that it was to act as a BR — with top-most rated borrowers getting funds at the rate. But it had created confusion – what is the BPLR to signal if the world borrowers both below and above it. Folks who borrowed below the BPLR had little reason to complain if it (the BPLR) continued to hold firm despite repeated policy rates cuts; ones who borrowed above it thought the world was unfair to them! The BR had just one consequence – the practice of lending below it came to end. But banks continued to say that their BR could not be reduced despite policy rate cuts as their cost of funds (on deposits and borrowings contracted earlier) remained high. It’s this stand of banks which prompted Rajan to say “we are not looking for a specific number (on the BR cuts) and saying unless this happens, nothing more will happen. But we want to facilitate the process of transmission. I do not see an environment where credit growth is tepid, banks are sitting on money and their marginal cost of funding (has) fallen, the notion that it hasn't fallen is nonsense, it has fallen”. Agrawal observes that yields of banks that lend mostly on a floating rate basis will be significantly impacted in an environment of falling interest rates – that floating rate is pitched over the BR. As the BR falls (and along with it the floating rate), so will the interest income of banks. And that banks with low levels of current and saving accounts, or relatively longer tenure-term deposits, will also be majorly affected. That’s becaus, their cost of funds will not come down soon enough -- as they will continue to payment interest to depositors at the old rate before a policy rate cut. The good news for banks (not for you and I) says Agrawal is that “in an increasing interest rate scenario, banks will tend to benefit as they will be able to immediately pass on any hike in deposit rate to the BR”. What about a cut in the BR next time Mint Road cuts policy rates? Adds Agrawal: “Given the impact on profitability, banks may shy away from cutting deposit rates, especially in times of low profitability, which will defeat the objective of quick transmission of cuts in the RBI’s policy rates”. You as customer will not win anytime soon.
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Raghu Mohan says NDA under Prime Minister Narendra Modi has got large parts of its banking act spot onOpen the Bharatiya Janata Party’s (BJP) manifesto for the May 2014 Lok Sabha elections, and you come across this bit on matters Plutus. That well before the British landed on our shores, we had “a well-developed banking system and equally renowned businessmen, along with its financiers, who were contributing to create a flourishing and progressive economy”. It may be Greek to refer to Plutus in a stock-taking on the BJP-led National Democratic Alliance (NDA) dispensation. But like the Greek God of Wealth who, blinded by Zeus, was able to dispense his gifts without prejudice, that’s what this dispensation aspired to anyway (blinded or not). Fifteen months on, it’s clear that the NDA under Prime Minister Narendra Modi has got large parts of its banking act spot on. You can quibble that the blue-print for much of this had been drawn up by the previous regime headed by Manmohan Singh, but it will only distract us from parts of act which have not been spot on. The hits… An unqualified success is the Pradhan Mantri Jan-Dhan Yojana (PMJDY). It’s not an original idea; the business correspondent-led banking model under Singh’s had got the concept right, but execution was far from good. And five months after its launch (or relaunch!) in August 2014, PMJDY made to the Guinness Book of World Records in terms of the number of bank accounts opened. North Block’s figures puts deposits under PMJDY at Rs 22,647 crore (19th August 2015); zero-balance accounts have dipped to 46.93 per cent to July 2015 from 76 per cent from September 2014. “The number of accounts grew by a whopping 27 per cent in 2014-15. This unprecedented and extraordinary development comes as a giant leap for banking in the country”, says Saurabh Tripathi, Partner & Director at the Boston Consulting Group. If the government can build on this -- and also plug leakages in annual subsidy transfers in excess of Rs 50,000 crore to PMJDY beneficiaries -- it would have scored a real winner. Early indications are, it will. On to the use of mobile telephony and e-banking to ensure financial inclusion. The Reserve Bank of India has granted ‘in-principle’ approval to 11 entities. Just how this pans out operationally remains to be seen, but there’s nothing to “judge” in this case. It was mere licensing unlike the PMJDY where the government decided to grease the wheel rather than reinvent it. The idea of payment banks was flagged off by Mint Road on 27 August 2013 in a policy discussion paper on `Banking Structure in India: The Way Forward”. It was picked up by the Committee on Comprehensive Financial Services for Small Businesses and Low Income Households (Chairman: Dr Nachiket Mor) which in its report (January 2014) to make a case for payment banks. But it’s an idea whose time has come. As Pawan Agrawal, Chief Analytical Officer-CRISIL says: “There could be a positive rub-off on existing banks partnering with payments banks through increased access to unbanked and under-banked areas in a cost-efficient manner. Bank credit to GDP in the east, north-east and central India is less than 60 per cent compared with 77 per cent for all-India”. It leads us to those who have money in banks which they can’t account for! Or black money. While the BJP did say in its manifesto that “by minimising the scope for corruption, we will ensure minimisation of the generation of black money”; that it “is committed to initiate the process of tracking down and bringing back black money stashed in foreign banks and offshore accounts” -- the reality is that it’s not as easy as going over to your friendly neighbourhood bank manager to help you sort out a problem. Should we be harsh on the government over its efforts to bring back the loot? No. The rhetoric of black money and jibes at the Gandhi family makes perfect sense on the campaign trail; it makes for good media copy. And you can’t fault the BJP for using it. But credit must be given to the dispensation that it not only stoked a debate on the subject, but has also taken the baby steps -- what’s realistically possible -- on it. … And the nearly so If the backbone of an economy are its banks, this one was nearly broken on account of non-performing assets (NPAs). In its manifesto, it said “NPAs have increased sharply over the past few years and the trend continues. BJP will take necessary steps to reduce NPAs in banking sector”. Truth be told there are no quick-fixes here. Mint Road’s Financial Stability Report (June 2015) observed that while risks to the banking sector had moderated marginally since September 2014, concerns remain over the continued weakness in asset quality indicated by the rising trend in bank’s stressed advances ratio. Gross NPAs went up to 4.6 per cent from 4.5 per cent between September 2014 and March 2015. So too restructured standard to 11.1 per cent (10.7 per cent). State-run banks recorded the highest level of stressed assets at 13.5 per cent of total advances as of March 2015. The net NPAs of banks remained unchanged at 2.5 per cent during September 2014 and March 2015. The FSR was of the view that the current deterioration may continue for few more quarters. That falling profit margins and debt repayment capabilities of India Inc add to these concerns though the overall leverage level in Indian economy is comfortable when compared to other jurisdictions. What’s heart-warming is that it has acted on the FSR’s suggestion that “in this context, the policy initiatives for improving the governance and management processes at public sector banks become significant”. The seven-point “Indradhanush” programme to improve the working of these banks is a welcome step. So too the step towards recapitalising these banks ahead of Basel-III capital adequacy norms which kick in from fiscal 2019 which will need about Rs 2,50,000 crore in core equity. Is this enough? While adequate capital has been provided for now, it may be not be enough if one goes by the FSR’s warning that bank asset quality may fall for a few more quarters. That’s because of the Rs 25,000 crore allocated in the current fiscal year, more than Rs 20,000 crore will be pumped in the coming months; the remaining is to be released based on the performance of the banks. “We believe that a lot of the capital would also go towards higher provisioning in the current fiscal”. Says Kaitav Shah, analyst at SBI Cap Securities. Given the state of the fisc, finance minister Arun Jaitely may well soon find that this genie will not go back into the bottle anytime soon. What’s one to make of the story so far? Well, Plutus is also lame; takes his time to arrive and winged as he is, leaves faster than he comes. And when his sight is restored, he’s able to determine who deserves his attention; he then wreaks havoc! Modi’s Reforms In A Logjam; Read Businessworld magazine 24 September Edition
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Despite the Reserve Bank of India (RBI) slashing the statutory liquidity ratio (SLR) — the percentage of deposits that banks have to invest in government securities (G-Secs) – over time to 21.3 per cent from 23 per cent, banks continue to hold around 28 per cent (by way of SLR). In its Annual Report for 2014-15, Mint Road explains the reasons for the excess holding of SLR by banks: “… the buffer providing access to collateralised borrowings from the wholesale funding market and the Reserve Bank. Maintaining excess SLR securities also helped banks to weather the impact of the current slow phase of the economic cycle on their balance sheets and earnings”. Simply, put what it means is that bank held excess by way of SLR – that is, they invested higher amounts in G-Secs — as they could pledge them to raise funds from the money markets; and that at a time of dip in asset quality, such investments stood them in good stead. Data on sectoral deployment of credit, which constitutes about 95 per cent of total bank credit by banks, indicate that deceleration in credit off-take in 2014-15 was more pronounced with respect to the industry and services sectors, which together constituted about 68 per cent of total non-food credit. Credit growth in the services sector was weighed down by its major components: trade and non-banking financial companies (NBFCs) that accounted for nearly 48 per cent of the total credit to the services sector. In the industrial sector, growth slowed down across sectors, particularly for infrastructure, basic metals and food processing. The sectors which witnessed lower incidence of non-performing assets such as personal loans saw higher growth during the year. Infrastructure accounts for nearly one-third of the credit to the industrial sector. Its main components are power and roads, constituting 60 and 18 per cent of the total infrastructure credit respectively. While deceleration in credit to the power sector was modest, the slowdown was sharp with respect to roads in 2014-15. Non-food credit growth decelerated sharply in 2014-15 to 9.3 per cent (year-on-year), with incremental non-food credit declining to Rs 5,50,000 crore from Rs 7,30,000 crore in the previous fiscal. A host of factors weighed down on credit off-take, including lower corporate sales, softening of inflation rate, risk aversion by banks due to rise in non-performing loans, and procedural delays in debt recovery. Some in Inc also shifted to alternative sources for financing. Sale of significantly larger amount of non-performing loans (Rs 31,000 crore) by banks to asset reconstruction companies (ARCs) during 2014- 15 also contributed to a deceleration in bank credit. Mint Road’s Annual Report is ominous. It says that viewed in conjunction with other indicators of investment activity such as stalled projects, capital goods imports, production and capex spending, the decline in the private investment intention appears to have become more pronounced in 2014-15 relative to the preceding year. As per the RBI’s data on new projects which were sanctioned financial assistance by banks and financial institutions (FIs) or funded through external commercial borrowings, foreign currency convertible bonds, domestic capital market issuance, investment intentions for such projects aggregated to Rs 14,590 billion during 2014-15 as against Rs 20,810 crore in the previous year. “A turnaround in the investment demand cycle, therefore, assumes critical importance to steer the economy on to a sustainable high growth trajectory. The recent experience suggests that a strong step up in public investment may be required to dispel the inertia constraining private investment and to crowd it in, given the robust business sentiment”, says RBI in its Annual Report. Key to this effort will be putting stranded investments in stalled projects back to work while ensuring the availability of key inputs such as power, land (especially for roads) and skilled labour. Steadfast implementation of structural reforms like the goods and services tax (GST) is also required to reinvigorate productivity and competitiveness. Well, we know that story well.
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North Block’s strategy to rehaul the affairs at state-run banks is commendable, but execution will be the key, says Raghu Mohan Raghu MohanThe first step came almost a week ago when it was announced that the Centre will infuse Rs 25,000 crore each during fiscal’s 2016 and 2017; and Rs 10,000 crore each over the next two fiscals. Last week (Friday), it said that the infusion of Rs 20,088 crore into thirteen state-run banks will be done in a month's time with the State Bank of India guzzling Rs 5,531 crore. The urgency is reflective of the precarious situation at several of these banks which are capital deficit ahead of Basel-III implementation which kicks in from fiscal 2019. Ananda Bhoumik, Managing Director & Chief Analytical Office, India Ratings & Research points out that while most state-run banks will be relieved at the end to uncertainty on the government's contribution, these banks will need to raise an additional Rs 15,000 crore from the equity market together with Rs 40,000 crore in bonds (additional tier-1 bonds) during the year. “In addition, our research suggests provisioning gap due to overleverage in distressed corporates, which may need to be filled in by equity. It is, therefore, imperative for these banks to improve performance and market valuations”, says Bhoumik. The issue of distressed assets in banks can’t be taken care of by mere provisioning – that's mere accounting for bad debts. To get back these assets in to “working” mode much more needs to be in the realm outside banking at the policy implementation level – they pertain to fuel supply, the poor state of discom’s financial health; and issues akin in aviation, steel and infrastructure. Until, these bottlenecks are resolved, recapitalising banks may turn out to be an exercise that throws good money after bad. Mint Road’s estimates had put the total amount of capital – equity and non-equity – for Basel III at closer to Rs 5 lakh crore; it is a dynamic numbers and depends on a whole range of factors – credit growth, dud loan provisioning and the technicalities under Basel III. Raman Uberoi, Business Head-CRISIL Ratings (Large Corporates) qualifies that “success will depend on relentless implementation, and staying the course no matter the obstacles. What’s encouraging is that the government has hit the ground running”. It was pointed out that conceptually, Indradhanush takes cognisance of both internal and external factors that influence the performance of state-run banks. The internal ones are better governance, greater efficiencies and a performance evaluation framework that incentivises management focus on capital conservation and credit rating. The external factors are linked to legal, recovery and dispute resolutions such as coercing promoters to sell non-core assets, setting up fraud resolution processes and six new Debt Recovery Tribunals, and enhancing the role of asset reconstruction companies. “We believe the clear timeline given for the setting up of a Bank Board Bureau and the announcement inducting professionals as non-executive chairmen will eventually drive qualitative changes in governance, strategy formulation, capital efficiency, and human resource practices. And allowing bonus and stock options for senior management will make public sector banks competitive and go a long way in attracting right talent”, adds Uberoi. The steps announded by the Centre is a summation of what has been articulated over time; just that it has been put in a neat capsule. On paper, Indradhanush looks as impressive as a rainbow; but it all depends on execution. A failure here can make it a rainbow chasing effort!P.S. Mission Indradhanush was to immunise kids against seven vaccine-preventable diseases. The latest one is to immunise banks!
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