Nifty Bank index buoyant as long-standing demands are met in Budget

Increase of 12.1 per cent clocked in two days is the highest gains posted by the index in almost a year

The Nifty Bank index has gained 12.1 per cent since Monday, thanks to the Union Budget promising to fulfil some of its financial sector's long-standing demands – that of setting up a development finance institution (DFI) and a bad bank to absorb the toxic assets in the banking system.

While the advantages of both the initiatives are likely to accrue only in the long run, foreign brokerages such as Morgan Stanley, JP Morgan and Credit Suisse were quick to reaffirm their overweight position on the Indian financial services sector.

“We believe the private sector banks could be in line for an increase in foreign direct investment limit from 74 per cent to 100 per cent,” analysts at Morgan Stanley note on the back of the structural changes proposed in the budget.

But the question is whether setting up a DFI or bad bank really changes the narrative for the banking sector?

DFI – an idea of the past

IFCI, erstwhile Industrial Credit and Investment Corporation of India (ICICI), now merged with ICICI Bank and likewise Industrial Development Bank of India (IDBI) – now IDBI Bank, and even Small Industries Development Bank of India (SIDBI) established in 1989 are examples of DFIs in India.

To that extent, the plan to step up another DFI with a capital base of Rs 20,000 crore intended at funding projects worth Rs five trillion in five years isn’t a new one. However, with the government once again focusing on upping its infrastructure spend and banks at the brink of a cleaner balance sheet, DFI as a concept is essential to heavy-lift the government’s infra-pipelines.

Analysts at Emkay Global Financial Services say higher system credit growth may be possible due to multiplier effects of DFIs, though the likelihood of cannibalisation with banks is apparent. But as a senior banker puts it, ensuring that past mistakes are not repeated is important for the model’s success. “DFI will not be a success if they have to follow Reserve Bank of India’s norms on income recognition and asset classification (IRAC). There will be an apparent asset-liability management (ALM) mismatch and what happened with IDBI or ICICI will become inevitable 20 years from now,” he said. The mandatory conversion/merger with banks because of the regulator’s nudge, also made the model a failure rather than achieve the objective it was set up for.

Bad bank – a game changer?

Essentially designed as an asset reconstruction company (ARC) and functioning similar to an asset management company (AMC), Rajnish Kumar, former chairman of State Bank of India was quite vocal that for the country’s credit demand to grow, it was imperative to have a backbone to absorb and support the asset quality of banks.

“How else can India achieve its $5 trillion economy aspiration,” asks Ananth Narayan, a banking sector expert agreeing with Kumar.

Therefore, a combination of a bad bank and DFI could go a long way in sprucing growth, which is the need of the hour and to that extent, banking stocks cheering these proposals is well taken.

“Creation of an asset management / asset reconstruction company is positive as it may help accelerate stress resolution,” say analysts at Credit Suisse. However, they note that with gross non-performing assets of sector at nine per cent and another nine per cent of asset written off, and 86 per cent of book provided for, transfer at book value to the bad bank will not release capital.

With the banking system just about getting back to feet after a massive cleanup, bad bank as a concept to begin with, may be more a sentiment booster in the near-term, rather than a financially attractive method to pawn off the stressed assets.

Sooner than later, focus will return to fundamentals, especially on asset quality which was a dampener in December quarter.