FCI rate sop to dent bank profits 4.5%

Pre-tax profit of public sector banks will come down by 4.5 per cent in the near term and by 10.2 per cent over time owing to the recently announced reduction in interest rates on bank loans to the Food Corporation of India (FCI) and redirection of a part of its borrowings to the debt market, according to an analysis made by Crisil.

The rating agency believes that while these measures will have a positive impact on FCI's financial profile, they would also affect banks' bottom-lines.

Currently, banks (mainly public sector banks) have an average exposure of Rs.42,000 crore to food credit. This bears an interest rate of 10.95 per cent, which will come down to 9.45 per cent once banks implement the proposed measure.

The announced measures include a 150-basis points (bps) reduction in the interest charged on bank loans to FCI and permission to raise Rs.5,000 crore from the domestic debt market.

The permission to access debt market opens up new avenues for FCI to reduce its borrowing costs. This will have two cascading effects. On the one hand, it will lower the Centre's subsidy bill to the extent of the reduction in interest expenses.

On the other, it will bring down interest income earned by banks on their food credit exposures. Banks with low profitability and high FCI exposure will be most susceptible to this impact.

Crisil says the reduction in interest income will add to the profitability pressures that banks are expected to face in the medium to long term on account of their falling investment income and interest on advances.

Investment yields will come down gradually owing to the re-pricing of the investment book, while interest on advances will be under pressure following difficulties in maintaining yields amid increasing competition.

According to Raman Uberoi, Director, financial sector ratings, Crisil, "Even at reduced interest rates, the returns on these loans will be significantly higher than that commensurate with the credit risk of the underlying exposure, which is integrally linked to the Government of India (GOI). Hence, the possibility of interest rates on food credit coming down further in the medium to long term cannot be ruled out."

If the interest rate on food credit comes down by another 100 bps, the impact on banks' pre tax profits will be 6.5 per cent, while the impact will be 8.5 per cent for a 200 bps decline in interest rates.

According to Krishnan Sitaraman, head, financial sector ratings, Crisil, "Other than the interest rate reduction on food credit, another key variable that could impact the banks' profitability is the extent of FCI's market borrowings. If these borrowings are backed by sovereign guarantees, the interest rates on these instruments will be significantly lower than even the proposed reduced rates on food credit."

In this analysis it has been assumed that the extent of FCI's market borrowings backed by sovereign guarantee could go up to 50 per cent of the banks' exposure to food credit.

In this scenario, Crisil estimates that the consequent impact on banks' pre tax profits will be to the extent of 7.9 per cent if interest rates continue to remain at 9.45 per cent.

This impact will rise to 9.0 per cent if there were a further 100 bps reduction in interest rates and 10.2 per cent if the reduction in interest rates is 200 bps.