Tamal Bandyopadhyay: Are PSU banks being greedy?

Until PSU banks can prune their bloated wage costs, their interest margins will remain high.

While the finance ministry's attempt to prevent PSU banks from raising interest rates has been widely criticised, on the face of things, these banks are making a killing. The net interest margin (NIM) of these banks is between 3-4 per cent, as compared to 2-3 per cent for private Indian banks and less than 2 per cent globally.

Nowhere in the world do commercial banks enjoy as much cushion in terms of NIM as the Indian public sector banks. Over the past five years when the interest rates displayed a secular decline, public sector banks did pass on the benefit to customers by slashing their lending rates, but the cut in deposit rates was even sharper. As a result of this, there has not been a huge impact on the industry's margin. In fact, the NIM of Punjab National Bank rose from 3.87 per cent in 2005, to 4 per cent in 2006.

But before you decide banks are greedy, it's a good idea to examine some more facts. The two key financial parameters that give an indication of banks' operational efficiency are NIM and 'spread'. NIM is arrived at dividing a bank's net interest income by its average interest-earning assets while spread is the margin between the yield on assets and cost of liabilities. On a standalone basis, State Bank of India's NIM came down sharply from 3.12 per cent in 2005, to 2.92 per cent. However, its NIM on the consolidated balance sheet at 3.48 per cent was just 0.01 per cent less than what it was a year ago. In case of Bank of Baroda, it fell from 3.40 per cent to 3.31 per cent, and Canara Bank from 3.41 per cent to 3.36 per cent, while for PNB, it actually rose.

In the private sector, HDFC Bank's NIM rose from 3.94 per cent to 4 per cent, and that of ICICI Bank, from 2.12 per cent to 2.16 per cent. In case of UTI Bank, however, the NIM fell marginally from 2.90 per cent to 2.85 per cent.

But NIM is only one of the indicators of banks' profitability and there are other structural issues that have a bearing on banks' bottomline. While the average NIM of Indian banks is double that of global banks, their return on assets (RoA) "" which is the single most important profitability indicator "" is comparable with their global peers. SBI and Bank of Baroda's RoA is less than 1 per cent, while that of Canara Bank and PNB is slightly above 1 per cent. In fact, despite a rise in NIM, the RoA of PNB dropped from 1.23 per cent in 2005, to 1.06 per cent in 2006. The RoA of ICICI Bank, HDFC Bank and UTI Bank is well above 1 per cent even though it fell substantially last year.

A large chunk of NIM is eaten away by operating expenses and credit cost, including provision for bad assets and write-offs. On an average, the operating expenses of public sector banks is above 2 per cent of assets and the wage bill alone accounts for three-fourth of the operating expenses. In case of SBI, the wage bill was 1.64 per cent of its total assets in 2006. The comparable figure for Bank of Baroda is 1.34 per cent, 1.14 per cent for Canara Bank, and 1.46 per cent for Punjab National Bank. Kolkata-based United Bank of India's wage bill is 1.89 per cent of its total assets. Another unlisted entity, Central Bank in Mumbai, is the second highest spender on wages "" 1.71 per cent of assets.

In contrast, the wage bill of HDFC Bank is 0.66 per cent. For ICICI Bank it is 0.43 per cent and for UTI Bank it is 0.36 per cent. However, the private sector banks' overall overhead cost is not too low compared with the PSU banks as they spend heavily on rolling out new branches and paying commission to direct sales agents for generating business.

The average cost of making provision and writing off bad assets at this point is less than 0.50 per cent of total assets. It could go down further if, in their aggression to build assets, banks do not pile up bad loans. The impact of the cost of provisions and write-offs could be even less on bank balance sheets if one takes into account the bad loan recovery every year.

So, it's not greed alone that has prompted banks to rush to hike their rates. There is an inherent inefficiency in the system on account of structural issues such as a bloated work force. This can be addressed by introducing another voluntary retirement scheme. The first VRS witnessed over a lakh bank employees marching out of the industry a few years ago. If the government does not have the political will to address such structural issues but still wants lower NIMs (and, therefore, interest rates), the only way is to buy back the free float of 15 listed PSU banks and SBI from the market and make them its wholly-owned subsidiaries. This will give the government a better handle to run the banks. Taking into account Tuesday's market capitalisation of these bank stocks, the cost of such a buyback would be over Rs 45,000 crore.