Can economic revival end problems of PSU banks?

Growth not enough; govt will have to reform ailing ones for private investors to fund capital needs

Bank stocks have outperformed the benchmarks by 100 per cent over the past 12 months. The market’s expectations ran ahead of the ground reality and investors starting stocking up on the financials, which is a proxy of the broader economy. The assumption was that a revival in the economy would automatically solve the problem of stressed assets and return of loan growth would take care of falling profitability. It’s these two assumptions that helped the Bank Nifty rise 82.5 per cent in the past 12 months, more than double the returns the Nifty has given. However, the quarterly performance of state-owned banks and the continued build-up in stressed loans make analysts question whether revival in the economy is enough to change the fortunes of the banking sector.

A section of the market is now questioning this theory, as revival in the economy might not be enough to solve the problems. Last month, Goldman Sachs wrote in a note: “We acknowledge the near to medium-term risk to earnings from slower reforms and their impact on the investment cycle.” Public sector banks account for about 70 per cent of the systemic loans and 90 per cent of the impaired assets in the entire banking system. While there is no absolute figure, banks account for a substantial portion of infrastructure loans and public sector banks for nearly 86 per cent of this exposure.

  Analysts at Jefferies say state-owned banks have neither the management bandwidth to pursue new assets/projects (notwithstanding the fact that project announcements had come off), nor the required level of capital to take on more exposure. “Clearly, the economic recovery hope does not reconcile with a delinquent banking system and, therefore, strengthens the case of an inevitable reform for state-owned banks that sets them on the path to recovery and sustainable profitability,” says the brokerage.

Most state-owned banks do not have the requisite capital to fund growth, even if credit growth were to revive in the next few quarters. Stressed assets have eroded capital structures. The tier-1 capital of state-owned banks hovers around four per cent levels, after adjusting for restructured assets. Once Basel-III norms kick in fully by 2019, banks will need growth capital and common equity tier-I capital. Together, the need for capital is expected to be close to $50 billion. In contrast, the sector has seen infusion of $1.2 billion over the past decade.

Given that the government might not be able to provide the required support, private capital will expect the government to put in place norms that would improve the management bandwidth of these banks. With the government bringing down its stake in public-sector banks to 52 per cent, these banks are estimated to see capital infusion of Rs 90,000 crore but this is still short of the required funds. The market will continue to focus on high-quality private banks till the government shows commitment to reforming public sector banks.