Tamal Bandyopadhyay: Indian banking unmasked

The inevitable has happened. In the second quarter of this fiscal, at least four listed commercial banks "" all in the old (pre-liberalisation) private sector "" have posted net losses. Another 20 banks of all hues "" private (old and new) and public sector "" have shown a drop in net profit for the same period. Contrast this with Q1 when only two banks reported a drop in net profit.

The decline in Q2 net profit ranges from 4.62 per cent to an incredible 82.08 per cent. Only 33 per cent of the listed banks "" 12 out of the 36 that have announced their results "" have recorded a growth in net profits in this period. Much of this was expected once interest rates started to rise. As a result of the fall in gilt prices and the rise in interest rates, or yield, bank treasury income "" the source of super-profits in earlier years "" has dropped drastically.

Overall, the collective net profits of the 36 listed banks have dropped by 6.85 per cent "" from Rs 4,572.46 crore in July-September 2003, to Rs 4,259.45 crore in the same quarter of 2004.

Look at operating profits and the picture is bleaker. Operating profit is a better barometer of bank performance since net profit is derived after making provisions and so on, and banks tend to have a flexible approach to provisioning.

Only eight banks have recorded a growth in operating profit; 26 have seen an erosion. Two of them, Bank of Punjab and ING Vysya Bank, have posted operating losses.

Several banks with higher net profits have recorded lower operating profits. For instance, Centurion Bank recorded the maximum growth in net profit but operating profit declined 83 per cent. Similarly, the State Bank of India's net profit is up by 9.42 per cent but operating profit is down by close to 9 per cent.

Now look at some other big public sector banks. Canara Bank has posted a 21.96 per cent growth in net profit but 42.43 per cent decline in operating profit. For Punjab National Bank, net profit grew by 37.63 per cent but operating profit dipped by over 25 per cent.

Another Delhi-Based public sector bank, Oriental Bank of Commerce, has shown a healthy 32 per cent growth in net profit but an over 33 per cent drop in operating profit. Similarly, Union Bank's net profit grew by 24 per cent but operating profit dropped over 6 per cent.

Why has this happened? Because these banks have drastically pruned their provisioning for sticky loans. Had they opted for aggressive provisioning, they would have ended up showing a less impressive growth or even a decline in net profits.

For instance, State Bank of India has cut its provisioning by almost 50 per cent in the second quarter "" from Rs 1511.58 crore to Rs 757.39 crore. Similarly, Punjab National Bank's provisioning is lower by close to 56 per cent; Canara Bank's provisioning is down by 86 per cent and Oriental Bank of Commerce 87.47 per cent. Overall, the operating profit of listed banks has dropped by 16.05 per cent.

What does this mean? With operating profit going down, banks' ability to make provisions is also being eroded. Some of them are making lower provision to keep their net profit growth intact.

In a situation where operating profit moves southwards, banks are finding it tough to make higher provisioning. As a result of this, their non-performing assets (NPAs) could go up. There has been a 26.92 per cent decline in the overall provisioning by the 36 listed commercial banks.

So why has there been a drastic drop in profits? The real reason for the dent in profit is the drastic fall in treasury income and profit, triggered by a reversal in interest rates. Only seven of the 36 listed banks have posted a growth in treasury income and five of them have recorded growth in treasury profit.

(Click here to see the table "The Numbers Game")

The seven banks that have shown a growth in treasury income are Allahabad Bank, Bank of Baroda, Syndicate Bank, State Bank of Bikaner and Jaipur, State Bank of Travancore, IDBI Bank and UTI Bank. The five banks posting a growth in treasury profits are Allahabad Bank, Indian Overseas Bank, Uco Bank, Union Bank and State Bank of Travancore.

But seven listed banks have actually made treasury losses and 24 of them have shown an erosion in treasury profits. Collectively, treasury income has dropped by 12 per cent "" from Rs 34,979.85 crore in the July-September 2003 quarter to Rs 30,657.22 crore in the July-September 2004 quarter. The fall in treasury profit is much sharper "" 43.92 per cent from Rs 10,384.70 crore to Rs 5823.99 crore.

So the simple arithmetic is: despite a Rs 2,200 crore rise in interest income, the 36 listed commercial banks' collective net profit has dropped by over Rs 1,300 crore. This is notwithstanding a more than Rs 1,300-crore drop in provisioning.

In other words, had they maintained the earlier level of provisioning, the fall in net profit would have been much sharper. The root cause of this is the over-Rs 4,500 crore drop in treasury profit.

Apart from a drastic fall in treasury profit, some of the banks have also taken a one-time hit by transferring a chunk of their statutory liquidity ratio (SLR) portfolios to the held-to-maturity (HTM) category, now that the Reserve Bank of India has allowed them to do so.

The interest rate cycle has changed and the rates can only go up from now. The yield on 10-year benchmark paper, which dropped below 5 per cent in October last year, is now inching towards 7 per cent.

The banking community took it easy over the past four years and maximised their profits by chasing government bonds. They have also cleaned their balance sheets with the money earned from treasury operations. With the reversal in the interest rate cycle, the scene has changed dramatically.

Now that the focus is shifting to the core banking business (that is: lending) and quality of assets, it will be no exaggeration to say that the next two years will separate the men from the boys.