The challenging times are far from over for India's banks. The slowdown in credit growth, deterioration in asset quality, and the consequent reduction in profitability continue to weigh heavily on the banking sector.
The high interest rates, moderating growth in gross domestic product (GDP), and tapering corporate profitability continue to tell on asset quality.
And, increasingly, a substantial proportion of banks' advances to the corporate sector are being restructured —advances exceeding Rs 2-lakh crore are to be restructured between 2011-12 (refers to financial year April 1 to March 31) and 2012-13.
The restructuring will, no doubt, help banks limit the increase in their reported NPAs (non-performing assets). Nevertheless, continued delinquencies in loans to micro, small and medium enterprises (MSMEs) and mid-corporates will drive an increase in gross NPAs — to 3.2 per cent by end-March 2013, from 2.9 per cent as on March 31, 2012.
High provisioning costs will constrain earnings: banks' return on assets (RoA) may decline below 1 per cent in 2012-13 from 1 per cent in the previous year. However arduous and daunting these challenges are, the banks' adequate capitalisation will continue to cushion them against asset quality pressures, just as stable resource profiles will support the banks' credit risk profiles.
Loan restructuring
The sizeable loan restructuring by banks is indicative of corporate India's strained credit quality. Sectors with large debt are likely to witness higher restructuring: nearly 30 per cent of the total restructuring, for instance, is expected to be in loans to the power sector.
The other susceptible sectors include aviation, construction and engineering, steel, textiles, and telecom infrastructure.
Restructuring of loans of more than Rs 1.25-lakh crore were either completed or under way as on March 31, 2012. The current restructuring is qualitatively different from those in 2008-09 and 2009-10. While much of the earlier restructuring was in MSME accounts, the current restructuring is predominantly among the large corporate exposures.
Crisil believes that the sizeable restructuring will help restrict increase in banks' reported gross NPAs to around 3.2 per cent as on March 31, 2013, from 2.9 per cent at end-March 2012 (chart 1).
The increase in gross NPAs will be driven primarily by the weakened debt servicing ability of the mid-corporates and MSMEs.
Profitability challenges
If growth in India's economy is significantly slower than Crisil's expectations (at 6.5 per cent), the banks' gross NPAs could exceed 3.5 per cent by March 2013.
Crisil believes that the profitability of banks will remain under pressure in the near term, with RoA remaining between 0.95 per cent and 1 per cent in 2012-13 (chart 2), due largely to high borrowing and provisioning costs.
While the overall borrowing costs increased by over 100 basis points in 2011-12, banks have passed on large portions of this increase to their borrowers.
The banks' net interest margin (NIM) declined marginally to around 2.8 per cent in 2011-12 from 2.9 per cent, a year ago.
Given that term deposits would continue to be renewed at high interest rates, the borrowings costs of banks are not expected to reduce significantly, resulting in their NIM remaining at less than 3 per cent in 2012-13.
Provisioning costs will remain high in 2012-13, given the pressure on banks' asset quality.
However, with interest rates likely to reduce in the second half of 2012-13, banks' profitability may be supported partly by treasury income, which will mitigate the impact of provisioning costs.
Capitalisation support
Banks continue to have adequate capitalisation, with average Tier-I and overall capital adequacy ratio (CAR) of about 10 per cent and 14 per cent, respectively, as on March 31, 2012.
Banks' net worth coverage for net NPAs reduced to around eight times as on March 31, 2012 (from 11 times as on March 31, 2011), but continues to cushion the sector against asset-side risks.
Public sector banks (PSBs) continue to benefit from strong support from the Government. The Government together with LIC infused capital of around Rs 43,000 crore in PSBs between 2008-09 and 2011-12, with the bulk of this infusion consisting of equity capital.
The Government has announced fresh infusion of equity of around Rs 16,000 crore in PSBs for 2012-13 to support their growth plans.
Also, private sector banks continue to maintain healthy capitalisation, with Tier-I and overall CAR of around 12 per cent and 16 per cent as on March 31, 2012, supported by strong internal accruals and ability to raise fresh capital.
Given the adequate capitalisation, the banks are well placed to migrate to RBI's Basel III norms by January 2013.
However, as the minimum Tier-I CAR stipulation under Basel III increases to 9.5 per cent by March 2018, the additional equity capital requirements will increase significantly and banks will need to potentially raise equity capital of Rs 2.7-lakh crore by end-March 2018.
Resource profile
Banks have maintained stable, low-cost current and savings account (CASA) deposits at around 34 per cent as on March 31, 2012 (35.5 per cent as on March 31, 2011).
Crisil expects that the banks' retail deposits (savings and retail term deposits) will continue to be healthy at around 60 per cent of their aggregate deposits.
The overall deposit growth, however, slowed down to around 15 per cent in 2011-12 from 18.3 per cent in 2010-11, because of tight liquidity and inflationary pressures, resulting in reduced float in the system.
While Crisil believes that the banks' resource profiles will remain stable, supported largely by healthy CASA deposits, banks will need to focus on increasing the share of retail deposits, and reducing their dependence on high-cost wholesale deposits.
(The author is President, Crisil Ratings.)