Why banks have had a bittersweet experience with Rajan

It has been a rocky road for the banking sector over the past three years.

A long spell of economic slowdown and stretched corporate balance sheets have seen the sector reeling under mounting bad loans and weak credit offtake.

When Raghuram Rajan assumed office as Governor of the Reserve Bank of India in September 2013, he had his task cut out.

After growing at 18-20 per cent in the preceding two years, bank credit growth had already slipped to 13-odd per cent in 2013.

Bad loans had started to pinch, with stressed loans (including restructured loans) exceeding 10 per cent for PSU banks.

On the rate front too, banks did not have much respite. Rajan, after taking charge, raised the key policy repo rate and stayed pat on rates through 2014, on concerns of rising inflation.

The much-needed relief for banks came only in 2015, when the RBI started to cut rates. But lower interest rates, as expected, failed to revive credit growth and reduce loan delinquencies.

Over the last three years, banks’ earnings have shrunk substantially. Listed banks’ core net interest income grew by a modest 7per cent in 2015-16, compared to 10-12 per cent in the previous two years. Earnings fell by a steep 70 per cent in the 2016 fiscal, driven mainly by PSU banks’ abysmal performance.

A lot is to be blamed on the slow pace of growth in the broader economy, for bank credit has always grown at a multiple to GDP growth. After growing over 20 per cent annually since 2005, credit growth slipped to 13-14 per cent in 2013 and 2014 and fell to decadal low levels of 8-9 per cent in 2014-15 and 2015-16.

While the economy’s slow growth has played havoc with banks’ earnings, the RBI’s many tweaks to lending rate norms, liquidity and asset quality have had a bittersweet impact on banks’ performance.

Through 2015, as the RBI finally embarked on its rate-easing exercise, banks were constantly nudged to lower rates. The RBI’s 150 basis point rate cut was followed by a 60-70 basis points reduction in banks’ lending rates. This impacted earnings to an extent, given that banks’ margins were already under pressure owing to bad loans.

But the constant tweaks in calculation of banks’ benchmark lending rate and the introduction of the marginal cost based lending rates (MCLR) in April this year, have left banks with less flexibility on deciding their lending rates.

In the past three years, while private banks, given their retail exposure and strong low cost deposit base, have managed to maintain margins, PSU banks’ net interest margins fell by about 60 basis points.

Concerned over banks misusing the restructuring tool – where borrowers have sought more lenient terms – the Governor stood his ground and closed the window in March 2015. This led to a sharp rise in provisioning for banks that were forced to come clean on their bad loans. But the RBI did bring in other measures to offer some respite.

In 2014, the RBI introduced the 5:25 scheme, offering flexibility in loan structuring and refinancing, and allowing banks to raise funds specifically for lending to the infrastructure sector without regulatory requirements such as CRR, SLR and Priority Sector Lending targets. This was a huge positive for banks as they could draw up a repayment schedule for 25 years, and opt for refinancing it after a period of, say, five years. Banks have been extensively using this tool to restructure loans.

In 2015, the RBI issued norms for Strategic Debt Restructuring (SDR), which gave lenders the right to convert their outstanding loans into a majority equity stake if they feel that a change in ownership can help turnaround the borrower’s business. This gave banks an additional tool to cope with their bad-loan problems. Loans under SDR and the 5:25 scheme put together account for about 3-5 per cent of loans for many banks.

Recently, to provide further relief to banks, the RBI unveiled a new tool – Scheme for Sustainable Structuring of Stressed Assets or S4A – that allows banks to convert up to half of the loans to stressed corporates into equity or equity-like instruments.

While these measures helped ease the pressure of stressed loans on banks to an extent, the RBI’s much-talked-about asset quality review (AQR) left banks saddled with more bad loans.

In just one quarter, banks’ bad loans rose an alarming ₹1 lakh crore. Many PSU banks have reported record losses in the latest March quarter.

Bad loans now stand at about 7 per cent of loans, a sharp rise from the 4.5-odd per cent levels seen last year. While banks’ earnings have taken a sharp knock, the RBI’s AQR has to some extent cleaned up banks’ balance sheet and prepped them for the next leg of lending.

In the near term, it is likely that banks still have to tackle bad loans and anaemic credit offtake.

Even as Raghuram Rajan steps down in September, it is clear that banks will now look to the Centre to revive the sector, by kick-starting fresh investments and freeing up capital locked up in older projects.

After all, if banks’ performance in the past three years is any indication, credit demand cannot be spurred by lower interest rates alone.

After bringing in new measures to help banks manage stressed assets and its swachh banks initiative, Rajan has lobbed the ball back into the Centre’s court to revive this critical sector.