Tamal Bandyopadhyay: Why our banks are more bankable now

What has prompted the re-rating of banks?

Since the beginning of the financial year (between April 1 and November 14), the market capitalisation of 37 listed commercial banks has risen by 22.46 per cent. In the last five months, between June 14 (when the BSE Sensex plunged below the 9,000-mark after hitting 12,600 in May) and November 14, the market cap of the banking industry rose by a phenomenal 64.06 per cent "" from Rs 192,117 crore to Rs 315,189 crore.

Prima facie, there is nothing unusual about it as, since mid-June, the BSE Sensex itself has risen by 50 per cent. So, bank stocks have just outperformed the benchmark index. But what makes the stock movement noteworthy is the fact that, at the beginning of the year, most analysts (including this columnist) almost wrote off bank stocks amid widespread apprehensions that Indian banks would not be able to handle the pressure of rising interest rates. This has not happened and the market has re-rated banks. The profitability of commercial banks is getting stronger due to higher interest and other income.

The interest income of 24 public sector banks (this study does not include United Bank of India, Central Bank and Punjab & Sind Bank and State Bank of Hyderabad as the results of these three unlisted banks were not available at the time of writing this piece) in the first half of 2006-07 has risen by 16.80 per cent against 14.95 per cent in whole of last year. Their other income too, has risen by 2.14 per cent in April-September 2006 against a 2.28 per cent drop in 2005-06. Similarly, the interest income of 16 private banks has gone up by 53.76 per cent in the first half of the current financial year against a 38.15 per cent rise in the last full year.

Theoretically, commercial banks can enjoy the best of the both worlds. In a low interest rate regime, they make money trading government bonds, while in a rising interest rate scenario, income comes from the credit portfolio. However, often it is seen that banks are more comfortable with trading the near zero-risk sovereign bonds than propping up their interest income by aggressively disbursing loans as a faster pace of loan growth always runs the risk of accumulation of bad assets.

Till now, Indian banks have been able to play the balancing act remarkably well.

In 2004-05, when the first signs of interest rates moving northwards were seen, the banking sector's net profit declined by 9.14 per cent. Last year, the trend was reversed and banks' net profit on an average rose by 16.84 per cent.

However, public sector banks remained a drag with just 5.57 net profit growth while average net profit of private banks rose by over 41 per cent. In the first half of 2006-07, public sector banks have regained the shine. The 24 banks studied here have posted a 12.91 per cent growth in their net profit against a 6.22 per cent growth last year. Sixteen private banks' net profits has grown an average by 34.75 per cent against 42.70 per cent last year. Seven PSU banks had posted a drop in their net profit last year. In contrast, not a single PSU bank has shown a decline in its net profit in the first half of this year. In the pack of private banks, four had recorded a drop in net profit last year. The comparable figure for the first half is just one.

For some of the PSU banks, the drop in net profit was very sharp last year. For instance, Bank of Maharashtra's net profit was down from Rs 177 crore in 2004-05 to Rs 51 crore in 2005-06. In the case of Vijaya Bank, it was down to Rs 127 crore from Rs 381 crore. Both these banks have scripted a different story this year. In the first half, Bank of Maharashtra's net profit has been Rs 122 crore, almost two and a half times the last full year's net profit. Vijaya Bank's net profit in the first half has been Rs 175 crore. Dena Bank, which had posted Rs 73 crore net profit last year, the lowest among PSU banks, has recorded a net profit of Rs 87 crore in the first half of this year.

Among the private banks, the two worst performers last year were Ing Vysya and Bank of Rajasthan. While Ing Vysya's net profit last year was a single-digit figure, Bank of Rajasthan had posted a net profit of Rs 15.26 crore "" much lower than its previous year's net profit.

In the first half of current year, Ing Vysya has posted over Rs 56 crore as net profit and for Bank of Rajasthan, the net profit is over Rs 75 crore. Development Credit Bank, the only private bank to be in the red last year, has also bounced back with a Rs 5 crore net profit in the first half.

In overall terms, the banking industry has put up a better show in terms of operating profit too. In 2005-06, 12 of the 24 PSU banks had shown a drop in their operating profits. In the first half of this year, the number has come down to five. In the case of private banks, only one player has shown a drop in its operating profit in the first half of the year, against five in all of last year.

On an average, PSU banks' operating profits in the first half has grown by close to 9 per cent against 1.80 per cent last year. However, private banks have shown a drop in their operating profit growth "" from 48.21 per cent last year to 42.10 per cent in the first half.

Apart from higher interest and other income, the third contributing factor to the banking industry's spectacular performance in the first half is lower provisioning. Banks need to provide to contain their non-performing assets (NPAs). PSU banks' provisioning in the first half has dropped by 13.62 per cent "" from Rs 6,893 crore to Rs 5,954 crore.

In other words, had they gone for aggressive provisioning, in the first half of this year, their net profit growth would have been lower.

However, this does not take away the shine from the banking industry's overall performance as, by and large, all of them have been able to maintain the level of their net non-performing assets or even lower them. The sole exception is Oriental Bank of Commerce. Even in this case, the net NPA level has gone up by just one basis point "" from 0.49 per cent in March 2006 to 0.50 per cent in September.