Big Story | How banks are caught in the Covid grip

“Last year we said, ‘Things can’t go on like this,’ and they didn’t, they got worse.” — Will Rogers (American humorist, actor and author).

There is no better way to sum up the unceasing turmoil that has been gripping the Indian banking system over the past 4-5 years. The Covid-19 pandemic that has thrown our economy out of kilter, to say the least, has made the road to recovery much longer and tougher for the banking sector.

The recent downgrade of India’s sovereign rating by Moody’s has put the spotlight back on the stress in the financial system that is only growing deeper.

Weak bank balance sheets and persisting asset-quality pressure have impaired India’s growth potential to a large extent in recent years.

Following the sovereign downgrade (to Baa3 from Baa2), Moody’s also took rating action on 11 Indian banks — downgrading the long-term local and foreign currency deposit ratings of HDFC Bank and SBI to Baa3 in line with the sovereign rating. According to Moody’s, Covid-19 will accelerate the deterioration of banks’ asset quality and profitability, with the longer and broader economic slowdown only accentuating the pain further.

The Centre’s fiscal stimulus package and the RBI’s measures to tackle the ongoing pandemic crisis have only made matters worse for the ailing sector. A chunk of these moves pertains to loans and liquidity measures that have put a huge burden on banks.

So, is it all gloom and doom for the entire banking sector? Are there stocks within the beaten-down sector that can hold their ground in these volatile times? We deep-dive into numbers to find some answers.

Plummeting credit growth

Legacy issues

Bank credit is mostly a function of the underlying activity in the economy. Hence, while robust GDP growth drove a credit growth of 17-20 per cent between FY09 and FY12, significant fall in economic growth over the past few years has adversely impacted credit growth that has mostly been languishing in single digits since FY15.

Credit growth has also been impacted by banks’ weak balance sheets. This is evident from the shrinking bank credit to GDP growth multiple over the past 3-4 years. Bank credit growth until FY14 was mostly 2.5-3 times the real GDP growth or 1-1.2 times nominal GDP growth. But since FY15, this multiple has shrunk substantially to 1-1.5 times real GDP growth and under 1 time nominal GDP growth.

The other key issue has been the lopsided growth in some segments.

Even as growth in credit to industry slowed significantly over the past few years, retail loans — led by unsecured loans — continued to sport double-digit growth. Credit cards and personal loans have grown at a CAGR of 29 per cent and 25 per cent, respectively, since FY15.

This unbridled growth in unsecured loans can haunt banks (discussed later) amid the pandemic-led income and job losses.

What lies ahead

According to the latest data published by the RBI for April — the first full month after the lockdown — while there was a slight uptick in credit to industry (large companies), this is most likely temporary as it could be due to higher utilisation of working capital limits and moratorium on loans (lower repayments and accumulation of interest).

It is important to note here that contrary to past trends, retail loan growth slowed notably in April, as credit cards saw a sharp decline in growth to 4.8 per cent (10 per cent decline m-o-m) owing to the Covid crisis. This broadly reflects banks’ wariness to lend and the underlying weak credit demand, which is likely to continue over the next one year.

However, the one critical component of credit growth that will need monitoring is the accumulation of interest on working capital facilities or on loans under moratorium that may bump up figures temporarily.

With GDP growth for FY21 expected to shrink by 5-6 per cent and the recovery thereafter to be long-drawn, credit growth will remain muted over the medium term.

How listed players fare

Banks that have declared their March-quarter results carry tell-tale signs of the disruption in lending activity in the latter part of March, when the first phase of the lockdown began.

While the overall growth for the quarter appears healthy for most private banks, it is evident that in the first quarter of FY21, when the full impact of the lockdown will be felt, credit growth will be severely impacted.

For instance, for IndusInd Bank that delivered strong loan growth of 25-30 per cent in the past few years, loan growth in the March quarter slipped notably to 11 per cent y-o-y. For the bank, the outflow of deposits during the March quarter (a fallout of the YES Bank crisis) was an added dampener to growth.

While HDFC Bank delivered loan growth of 21 per cent in the March quarter, the management stated that the lockdown had impacted the bank’s business — in terms of loan originations, distribution of third-party products and collection efforts.

The bank has been witnessing a slowdown in retail loans since FY19, and in the March quarter, the slowdown was led by segments such as auto, two-wheeler and CV (commercial vehicle)/construction equipment.

Axis Bank reported loan growth of 15 per cent during the March quarter, led by 24 per cent growth in retail. The bank’s share of retails loans in overall loans has gone up significantly over the past few years — from 45 per cent in FY17 to 53 per cent in FY20. Amid the pandemic-led slowdown, growth in the retail segment is likely to fall substantially.

The loan growth for ICICI Bank, too, in the March quarter was impacted due to Covid-19.

The domestic loan book grew by 12.9 per cent in the March quarter, down from 16.5 per cent growth in the December quarter.

SBI’s domestic loan growth has been steadily falling over the past four quarters.

In the March quarter, domestic loans grew by a muted 3.7 per cent (down from 5 per cent in the December quarter).

March-quarter results of other public sector banks are awaited. Most of these banks already stand on very weak grounds. Bank of Baroda, after its merger with Vijaya Bank and Dena Bank, for instance, continues to be weighed down by a sharp rise in bad loans and losses.

The growth in other larger PSU Banks — PNB, Union Bank, Indian Bank, Canara Bank — will be challenged owing to the ongoing merger exercise.

The bad loan saga

Legacy issues

It is well-known now that the genesis of the bad loan saga lies in the excessive lending between 2009 and 2013. But the persisting slowdown in the economy, lack of governance reforms in PSBs and the RBI’s massive clean-up drive over the past five years have weakened bank balance sheets significantly.

From 3.8 per cent levels in FY14, gross NPAs (non-performing assets) shot up to 9-10 per cent levels by FY19 for the entire banking system. For listed private sector and PSU banks, bad loans have grown by 30-40 per cent CAGR (between FY14 and FY19).

The break-out of the IL&FS and DHFL crisis in late 2018 made matters worse.

The spill-over effect of the NBFC crisis and heightened stress in a few corporate groups took a further toll on banks’ asset quality. Bad loans have continued to trend up in FY20.

With banks continuing to carry the burden of legacy NPAs owing to poor resolution (Insolvency and Bankruptcy Code (IBC) has been a disappointment so far) and with stress set to rise owing to the Covid crisis, asset quality will deteriorate sharply in the coming quarters.

What lies ahead

With the real GDP in the economy expected to plunge by 5-6 per cent in FY21, banks will bear the brunt of both a sharp slowdown in credit off-take and a rise in insolvencies among stressed corporates and individuals. An SBI report indicates that the GDP loss in Q1 could be humongous, even exceed 40 per cent.

The RBI’s six-month moratorium on term loans (along with asset classification standstill) and deferment of interest on working capital facilities by six months, though offer near-term respite, present a graver issue for the long run.

About 30-40 per cent of loans are under moratorium already (based on banks’ commentary post March-quarter results). In the coming months, more borrowers could opt for relief under the moratorium. With the impact of the pandemic evidently long-drawn, delinquencies will rise once the moratorium is lifted in September. On the working capital front, too, companies may need more leeway on repaying the interest (beyond March 2021).

The suspension of fresh insolvency cases under IBC post March 25 (for a period of six months, which can be extended up to a year), is also a big dampener. As such, finding buyers for stressed assets over the next year (for existing insolvency cases) will be a herculean task.

Of the 3,774 cases admitted till date (as of March 2020), only 221 have seen the approval of a resolution plan. Of the 2,170 cases undergoing resolution, 738 have been in the system for over 270 days.

The ban on fresh insolvency pleas will lead to a ssurge in cases being referred to IBC after six months or a year, clogging the IBC machinery. Banks may also have to take steeper haircuts owing to erosion of value of underlying assets and low buyer interest.

Recovery rates for banks under IBC is already poor at 30-35 per cent (20-25 per cent if we exclude big cases).

How listed players fare

Slippages and bad loan provisioning (additional provisions for Covid-19-related stress) remained elevated for most banks in the March quarter. For HDFC Bank, bad loans fell sequentially, thanks to the moratorium granted to its borrowers.

While the moratorium usage is low (until March), it could rise in the coming months.

Also the bank’s relatively high share of credit cards and personal loans (within retail) could lead to higher defaults. But it holds healthy provisioning (provisions for the quarter include ₹1,550 crore relating to Covid-19), which offers comfort.

For Axis Bank, while there was a significant fall in slippages in the March quarter, a clearer picture on asset quality will only emerge after the moratorium on loans is lifted in September (25-28 per cent of loans under moratorium until April 25).

The bank has made large provisions (₹3,000 crore related to Covid-19).

For ICICI Bank, slippages increased significantly, mainly owing to two specific accounts.

The bank’s slippages could remain elevated in the coming quarters. Loans under moratorium constituted about 30 per cent of its total loans (end-April). But the bank made sizeable provisions of ₹2,725 crore towards Covid-19.

For SBI, slippages halved to ₹8,105 crore in the March quarter (from the December quarter). But despite the bank having recognised huge stress in its corporate as well as agri book over the past year, the risk of rise in delinquencies in the retail book remains. The bank’s Covid-related provision to the tune of ₹938 crore is much lower than that of its private peers.

Capital/liquidity conundrum

Legacy issues

Capital crunch has become a persisting issue for banks over the past few years, in particular for PSU banks that have continued to rely on the Centre, time and again, to bail them out.

But much of the capital infused has gone into absorbing losses than funding growth. In fact, in FY18, the Centre had announced a mega recap rescue plan that has proved to be a damp squib, with many PSU banks still capital-starved. The Centre has infused a massive ₹2.7-lakh crore into PSBs between FY18 and FY20.

Many leading private banks, however, have been better-placed on the capital front, though the rise in bad loan provisioning has weighed on their capital ratios in recent years.

Interestingly, both private and public banks had been increasingly raising capital through additional Tier-I bonds (AT1 bonds) in the past few years (sudden surge in 2016 and 2017). The YES Bank fiasco that led to its AT1 bonds being written down fully, can impact investor interest in these bonds, hence, limiting banks’ ability to raise capital through such bonds.

What lies ahead

The Budget this time around did not set aside any money for recapitalisation of PSU banks.

Instead, it nudged PSU banks to raise money from the capital market, which, given the current volatile times and weak investor interest, may be difficult.

It appears that the Centre will have to shoulder the burden of pumping in more capital into PSBs this year — and that too frontload it. A back-of-the- envelope calculation and various reports suggest about ₹1-lakh crore of recapitalisation is required in FY21.

Recapitalisation of PSU banks has been through recap bonds over the past three years (essentially, the Centre borrows from banks to pump capital back into them). How the recap is done this year will need to be seen.

If capital is a challenge for PSU banks, for a few private sector banks, liquidity or weak deposit flows can become their Achilles heel. The YES Bank fiasco has had an uncanny impact on the deposit flows of some private sector banks.

IndusInd Bank and RBL Bank, for instance, had seen some outflows in deposits in March.

How listed players fare

Through most of last year, the overall credit-deposit (CD) ratio at the system level was 75-78 per cent. This implies that banks were able to deploy ₹75-78 out of every ₹100 deposited as loans.

While this may seem healthy, at the micro-level, the liquidity situation has been skewed.

For instance, private banks such as Kotak Mahindra Bank, IndusInd Bank, Axis Bank, RBL Bank, ICICI Bank and RBL Bank sported CD ratios of 80-90 per cent through most of last year, thanks to strong credit growth of 20-25 per cent. What this implies is that with deposit growth a challenge for some private banks, loan growth and profitability could be further impacted.

Also, after the RBI’s sharp repo rate cut (115 bps so far this year), banks’ lending rates will also fall significantly. But weak credit growth and inability to cut deposit rates sharply (owing to weak deposit growth), can impact a few private banks’ net interest margin and profitability in the coming quarters.

Private banks such as HDFC Bank, ICICI Bank sand Axis Bank are better-placed as they continue to see steady deposit flows. These banks are also well-capitalised to absorb losses.