2003-04: How the year was for commercial banks

ISSUE

A year of consolidation

D P Roy
Former chairman,
SBI Capital Markets Ltd

During 2003-04 non-food credit grew over Rs 100,000 crore but there was huge liquidity as deposits marched on to record a rise of over Rs 200,000 crore. Profitability has improved, thanks to non-operating profit on investment sales and government of India debt buyback programme.

The Reserve Bank of India (RBI) requires the premium to be utilised for non-performing assets (NPAs) provisioning, thereby lowering net NPA levels. Food credit declined by over Rs 13,000 crore, which, apart from aggravating liquidity, will impact public sector banks' profitability.

Exposure to commercial papers, equity and debt went down by Rs 5,000 crore as mutual funds having access to deposit pool were able to deploy funds through credit substitutes.

Special monitoring alerts was sounded in the RBI's credit policy for 2003-04. The coordination between RBI, the Securities and Exchange Board of India, the Insurance Regulatory Development Authority, and the National Housing Bank has to be proactive; and if necessary, a body like the Financial Services Authority of the UK maybe thought of.

Banks showed improved performance in FY 03-04 as industries like steel and cement had encouraging turnaround on top of 3 per cent interest rate reduction.

Despite RBI asking the Indian Banks' Association to advise banks on benchmarking PLR, the confusion continues as effective interest rates vary as much as 8 per cent. For top corporates, Mibor is relevant leading to substantive sub-PLR lending eroding the very concept of PLR. In this scenario, savings bank interest rates may be deregulated allowing banks to innovate and offer savings bank variant products.

Credit growth was largely fuelled by retail portfolio (mainly housing) which constitutes up to a third of the loan book in some banks and grew at a scorching 40-50 per cent. Universally, real estate prices are known to be cyclical and banks need to be cautious as housing loan maturities extend well beyond commercial term loans.

And without active term money market instruments such fixed rate loans are fraught with interest rate risks.

More importantly, the Banking Secrecy Act needs to be amended so that the credit information bureau is effective and can avert NPAs particularly in the retail segment.

As a preventive measure, banks may introduce an independent external credit review mechanism and in keeping with best practices RBI may make stiffer provisioning for impaired assets ab initio.

While launching asset reconstruction companies (ARCs) is laudable conflict of interest with the banks selling the asset has to be avoided by keeping transactions strictly at arms length. Some of the reduction of NPAs have been effected by transfer to ARCs but the real success can be judged only when the asset is disposed of.

The RBI's recent initiative in regulating unquoted investments and provisioning for investments including preference shares/debentures will bring transparency to banks balance sheets.

Consequently, investments in ARCs and pass through certificates (if unrated) have to be monitored and provided for. Given the fierce competition eroding margins and high cost of technology mergers of banks is imminent.

It is suggested that supervisory emphasis may shift from CAMEL to ROCA to make risk management paramount. It may also be worth revisiting whether the regulator should be required to review decisions to which he is a party by board representation.

Customer care to the fore

H N Sinor
Chief Executive,
Indian Banks' Association

Indian banks have done well during 2003-04. According to the available data, deposits grew by 17.3 per cent during 2003-04 compared with 16.1 per cent during the previous year. Investments in approved securities rose by 24.1 per cent, which was almost the same as in the preceding year (24.9 per cent).

As for credit offtake, food credit declined following mainly depletion of stocks due to higher offtake. As for non-food credit, there was some slackness during the initial five months, but expanded vigorously during the subsequent period. Banks had specifically focused on retail lending and housing. There was also notable increase in credit to small and medium enterprises.

Till March 19, 2004, the expansion in non-food credit aggregated Rs 1,19,684 crore showing an increase of 17.6 per cent. Credit to priority sector registered an increase of Rs. 33,720 crore (about 16 per cent) during the first 10 months.

Credit to housing and infrastructure went up by 33 per cent and 25 per cent, respectively. Retail credit also had substantially expanded. There was adequate liquidity in the system due mainly to the continuous inflow of foreign capital. Consequently, the financial markets were generally stable and the cost of funds tended to decline.

The call money rate, for instance, declined from 6.3 per cent by end-March 2003 to 4.3 per cent by end-March 2004. Yield on the benchmark 10-year government paper declined by over 120 basis points. Foreign exchange market was steady, except for the last week of the year when the rupee gained over 3 per cent against the US dollar.

Forward premiums on the dollar had significantly declined indicating, perhaps, the market's perception about the likely movement in the exchange rate. Over the year, the rupee-dollar spot rate gained 5.93 per cent. The premium on 1-month forward declined by 42.7 per cent but the decline was steep in 6-month forward (77.5 per cent).

Consequent to these trends, the banking sector would be posting a healthy growth in profits and profitability for the year 2003-04 on top of the extremely good performance during the preceding two continuous years.

There could be some improvement in the spread due to the surge in the share of retail loans, on which banks have the freedom to determine the rate of interest, in the total credit.

Similarly, the decline in the yield would improve their treasury income. Banks have used these gains for the purpose of cleaning up the balance sheet and have provided adequate coverage for their NPA portfolio. In fact, most banks have moved to 90 day provisioning norms.

Customer care has emerged on forefront of every bank's agenda and each one is quickly trying to put in place new products and services. Technology is also getting the attention that it needs and careful focus is given on appropriate technology spending. Similarly, risk management practices are also being strengthened.

There are, however, greater challenges ahead. Banks have to reckon the fact that treasury gains are not a sustainable revenue stream. Technology cost and wage bill are on rise and will continue to have pressure on operating expenses.

Market risks are for real and banks will have to make serious efforts to review that investment portfolio to strike a balance between yield pattern and the risk profile with specific reference to the duration of the portfolio. It would be advisable for banks to do a sensitivity analysis to gauge the resilience in adverse market conditions.