The banking sector will endure interesting times for the next year or longer. The Q3 and Q4 results of 2016-17 could be hard to digest. There’s been a spate of enforced deposits. Meanwhile, credit growth has dropped to 20-year lows. There is no clarity on key factors like the levels to which the Reserve Bank of India (RBI) intends to replenish cash, and no clear timelines for ‘remonetisation’. The credit-deposit (CD) ratio has hit lows previously seen in 2010, due to the combination of surging deposits and low credit demand. A low CD ratio should help banks cut rates to encourage borrowing. But, banks are also afraid of mass withdrawals as and when cash withdrawal limits are eased. Most new deposits are in savings accounts and there would be asset-liability mismatches if depositors take money out.
Another issue is that non-performing assets (NPAs) will rise due to the cash crunch. Many businesses will struggle to service loans. As of June 2016, gross NPAs were about Rs 6 lakh crore for the entire banking sector. That’s roughly 4.25% of gross domestic product(GDP). About 90% of the NPAs were held by public sector banks (PSBs), which contribute about 72% of credit disbursal. Private banks have fewer problems, though the quantum of stressed loans will rise there as well. This shows in valuations. Private banks trade at PEs of 30X plus, while PSBs are single-digit (or loss making).
There were more slippages in July-September 2016. By September, PSBs held NPAs of Rs 6.3 lakh crore. There will be more slippages in Q3 and Q4. Some of the NPAs might be papered over, with the RBI easing recognition norms. But, stresses will increase for sure.
Some sticky loans can be sold off to asset reconstruction companies at large discounts. Some loans can be split as suggested in the S4A scheme, (which was tweaked in November to plug some gaps). Banks are also empowered to take over defaulting companies and sell those to recover debt. But, auctioning bankrupt companies is not a core competency for bankers and this hasn’t really helped.
Massive provisioning is required, not only to wipe out losses but to meet commitments for higher tier-1 capital ratios under Basel-III. Bank shareholders must put in capital, or sell stakes. The majority shareholder in most stressed banks is the government.
The earlier estimate for PSB recapitalisation, in February 2016, was that Rs 1.8 lakh crore was required. The Government of India (GoI) was hoping to subscribe Rs 70,000 crore and let banks raise Rs 1.1 lakh crore. The recapitalisation estimate could now be close to Rs 3 lakh crore.
Some PSBs are technically bankrupt. There could be mergers to shore up balance sheets of merged entities. The better administered PSBs will survive, by making huge provisions and accepting losses. But, every PSB will need fresh capital.
Many observers thought demonetisation would have a positive impact. This was based on an assumption that several trillion in black money would not return to the system. By an accounting trick, such liabilities could be cancelled. The RBI could wipe off the corresponding assets on its balance sheet and pay a large dividend to GoI. That isn’t likely, since reports say over 90% of cancelled notes are already back with banks.
Managing new deposits could also be tricky. If most of the Rs 14.5 lakh crore comes back, banks must pay interest on it. Low credit demand makes it hard to lend out such huge sums (over 10% of GDP) at decent interest margins. The GoI can issue treasury bills at lower yields to fund the fiscal deficit (about 3.5% of GDP). But, banks will need to generate returns on the rest.
There are no obvious short-term solutions and a banking crisis could retard long-term growth. If banks must write off NPAs, and recapitalise “normally”, it will take a long time. As this happens, valuations (already low for PSBs) will drop lower. Quite possibly, a negative revaluation may pull down private bank valuations, too. The opposite is also possible — the prospect of enforced mergers and acquisitions may keep valuations bubbling.
Bargains will be available among PSBs at some stage. The investor will have to wait for a while, be selective and be prepared to face big risks. Another way to look at it is that growth cannot happen without the participation of PSBs. Ergo, some PSBs must be investment-worthy if you believe there will be future growth.
Disclaimer: These are personal views of the writer. They do not necessarily reflect the opinion of www.business-standard.com or the Business Standard newspaper
