Infected by economic gloom

The banking sector started the year 2013 on an upbeat note, only to end it in a sombre mood. The BSE Bankex, the bellwether for bank stocks, is down 13 per cent for the year, with the 25 per cent fall in the first nine months made up partly by gains of 13 per cent since September.

The year began with forecasts that the economic slowdown had bottomed out and that credit growth would soon pick up. By March, banks saw loan growth slow down to 14 per cent from 17 per cent in the previous year.

Deposit growth, too, tapered off to 13 per cent, pressuring banks to hold up their deposit rates. This mounted pressure on banks’ net interest margins (NIMs).

Public and private sector banks, however, handled these pressures quite differently. Private banks performed better than public sector ones on all counts – net interest income growth, loan growth and asset quality.

This led to private banks reporting an earnings growth of 25 per cent in the March quarter, while public sector banks (PSBs) saw profits plummet 19 per cent for the same period. The bad loan problems began to make its presence felt, too, with PSBs having a higher share of bad loans at around 3.5 per cent of their advances.

By June, the rupee began to weaken on fears that the US Fed would cut its bond purchases. This caused the RBI to focus on rescuing the rupee. On July 15, it delivered a rude jolt to the banking system by raising short-term interest rates from 8.25 to 10.25 per cent and capping bank borrowings from the repo window. The immediate fallout of these measures was an overnight spike in short-term borrowing costs and a severe liquidity crunch. This forced many banks to raise deposit and lending rates.

But banks’ performance in the September quarter turned out to be better than expected, led mainly by private banks enforcing better cost controls and increasing lending rates. Even PSBs saw only a marginal decline in NIMs. This was due to a sharp rise in loan growth to 18 per cent. But deposit growth remained muted at 15 per cent. Earnings for PSBs shrank by 25 per cent. Their gross NPAs increased to 4.2 per cent of loans, double the levels for private banks. Restructured assets, at 8.5 per cent of PSBs’ loans, were an even bigger problem.

Since September, with a new RBI Governor in place, there have been glimmers of hope. The central bank’s decision to cut short-term interest rates and look to other measures, such as non-resident deposits, to shore up the rupee, has eased margin pressure on banks. And while policy rates were raised twice after September, with the RBI signalling its intentions in advance, banks have had clarity on rate direction.

“The RBI’s policy has been more descriptive and elaborate, and the level of guidance and clarity has been far superior in the last three months than in the past,” says Ajay Marwaha, Head-Trading, Treasury, HDFC Bank.

A pick-up in GDP growth can decisively revive growth prospects for banks. Loan growth has historically been at 2.5-3 times real GDP growth. Private banks may be better placed to capitalise quickly on any turnaround.

“The worst of the credit slowdown is over. As project clearances come through, term loans will drive credit growth. After elections, there will also be a small pick-up in the investment cycle,” says Abheek Barua, Chief Economist, HDFC Bank.

For PSBs, as a large portion of their NPAs are from the stressed power and infrastructure sectors, on-the-ground progress on projects will hold the key to revival.

With the 10-year government security already at 9 per cent (factoring in another 25 basis points rate hike by March 2014), interest rates may have peaked. A moderation in rates in the next 12-18 months will reduce banks’ cost of funds and improve earnings. But as the US Fed prepares to cut down its bond buyback programme by $10 billion from January 2014, the rupee may need some watching.