Banks staring at worse abyss than 2008

 Ravi krishnan : live Mint :Mon, Aug 19 2013. 12 51 AM IST

Moody’s downgrade of three public sector banks is yet another reminder of the fragile health of the industry

Moody’s downgrade of the financial strength ratings of three public sector banks is yet another reminder of the fragile health of the industry. The reasons for the downgrade: a weak macroeconomic environment exacerbated by a depreciating rupee and high inflation.

This downgrade, combined with the broader market crash, drove the Bankex down to over a 62-week low. Still, in absolute levels, it is trading at 10,800 points, way above the low of 3,600 at the height of the North Atlantic financial crisis. In terms of past price to book values, the index is trading at 1.63 now compared with 0.97 then. Does this mean the market has not discounted enough the dangers to banks’ health in the present instance?

The gross non-performing assets as a proportion of total advances for the system stood at 3.4% at the end of March—a decadal low, according to the Reserve Bank of India (RBI) data. In March 2009, the ratio stood at 1.3%. The outlook is even worse. Standard and Poor’s expects bad loans to swell to 3.9% by the end of this fiscal year and to 4.4% by fiscal 2015. Even RBI’s own stress test predicts a rise in non-performing assets to 3.8% by September this year and 3.5% by March 2015, based on 5.7% economic growth and a now fanciful assumption of 6.8% short-term interest rates.

And this is not even counting restructured loans. According to Moody’s impaired loan ratios (gross NPAs plus restructured loans) for public sector banks is above 8%.

Sure, the setting aside of lower provisions has prevented many banks from spiralling into losses, but overall profit growth has come down. In fiscal year 2009, the combined net profit for all banks grew 27% and the following year, it was still 16%. In the just ended financial year, profit after tax grew just 10.6%.

The outlook is further muted when one looks at credit growth numbers. In fiscal year 2009, loan growth was still at 18% compared with around 14% now. Banks had more wherewithal to lend as well with the credit-to-deposit ratio at 72.4% at the end of fiscal year 2009 compared to 76.3% now.

In any case, despite a spate of rate cuts, the policy rate is 7.25% now, compared with 5.5% in the first quarter of 2009 and more easing on the way. With the falling rupee likely to add to inflationary pressures, further easing now looks far away. Sure, net interest margins are higher now compared to fiscal year 2009, but an increase in short-term funding costs will squeeze margins.

There was yet another favourable factor in the aftermath of the North Atlantic financial crisis—a fiscal stimulus. Despite that, NPAs jumped to 2.5% in fiscal year 2010 and net interest margins fell a bit. This time around, the government does not have the fiscal leeway for such tactics. Even in the case of recapitalization of state-owned banks, it provided for Rs.16,500 crore in financial year 2010 compared withRs.14,000 crore in this year’s budget, when balance sheet sizes are larger.

In short, a much-awaited economic recovery and RBI’s rupee defence have made operating conditions as tough as they have ever been in the last decade for banks.