Cash Crunch, Asset Quality Will Continue To Worry Banks In 2017
What’s in store for Indian banks in 2017?
From bad loans to demonetisation, 2016 proved to be an eventful year for banks. As bankers settle into 2017, both those issues will continue to be top of mind.
The immediate priority is to normalise banking operations which were thrown out of gear because of the government’s decision to withdraw notes of Rs 500 and Rs 1000 from circulation. Banks were at the centre of the process of exchanging old notes for new and have had to deal with increased costs due to these operations. Loan demand has also fallen to below 6 percent as attention of bank staff was redirected towards currency operations. On the positive side, banks are flush with deposits which may allow them to bring down their cost of funds.
The net reaction from the market, however, has been negative.
The Bank Nifty which had posted gains of 15.2 percent in 2016 before the November 8 announcement, is now looking at a gains of close to 7 percent for the year. This is in line with the benchmark Nifty50 index which had posted gains of 7.5 percent before the demonetisation announcement but is set to end the year with about a 2 percent gain.
Following the correction, the Bank Nifty is trading at 1.81 times the forward price-to-book value (based on 2017 earnings estimates), the lowest since 2013. Despite the attractive valuations, analysts remain skeptical as they fear that an additional layer of bad loans could emerge from small and medium enterprises.
Currently the non performing assets (NPAs) noise has been focused on the very large borrowers. I think there are a lot of small and medium sized borrowers who may actually have problems on account of the black money crackdown. So we could have a second tier of stress being created which may be actually detrimental for PSU banks.Anil Ahuja, Chief Executive Officer, IPEplus Advisor
Demonetisation Brings Higher Deposit Growth, Lower Loan Growth
The Government’s demonetisation decision has led to a surge in deposits, especially low-cost CASA (Current Account Savings Account) deposits. This, in turn, could bring down the cost of funds for banks.
Assuming 75 percent of the currency in circulation comes back into the system and 10 percent of that remains in the system (due to increased government effort on digitalization and increasing reliance on banking channels by individuals), CASA ratio would increase by 3-4 percent.Motilal Oswal Securities Report (December 2016)
However, banks may find it difficult to deploy these additional funds as demand for credit has slipped rapidly in the aftermath of demonetisation.
As per RBI data, credit growth for the fortnight ended December 9 declined to 5.76 percent on a year on year basis, compared to 6.6 percent and 7.9 percent in the preceding two fortnights.
Despite the improvement in banking sector liquidity, we do not expect credit growth to pick up meaningfully going forward. In fact credit growth could slow down even more, if loans to the retail sector, NBFCs and services – which are the key driver of credit growth at this stage (industrial sector credit is barely growing) – slow down further due to the adverse impact of the demonetisation in these segments.Deutsche Bank Report (December 2016)
Will Treasury Gains Save The Day?
Benchmark bond yields fell sharply after the government announced the demonetisation decision. From 6.80 percent on November 8, the benchmark 10-year bond yield fell to a low of 6.19 on 24 November, 2016. Since then, the yield has risen back to 6.50 percent.
Analysts say that banks, which are sitting on excess holdings of government securities, could have used this drop in yields to book profits. While banks are required to maintain a minimum bond holding of 20.75 percent of total deposits in the form of Statutory Liquidity Ratio (SLR), most lenders are holding in excess of that.
According to India Ratings and Research, potential treasury gains of Rs 38,200 crore could have be unlocked in financial year 2016-17 led by softening yields driving surplus liquidity. Even before demonetisation, bond yields had been softening through the course of 2016. For the calendar year, the benchmark 10-year bond yield has dropped 127 basis points.
The Rs 38,200 crore worth of potential treasury gains is significantly large, considering the banking sector reported a Rs 23,600 crore profit for FY16, and public sector banks reported a loss of Rs 17,700 crore. The development comes at a time when the banking sector is facing challenging conditions.India Ratings and Research Report (December 2016)
Banks that managed to book gains from their bond portfolio may be able to use to those funds to increase provisions against bad loans and strengthen their balancesheets.
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Also Read: 2016 In 16 Charts
Asset Quality Woes Remain
Bankers will also need to bring their attention back to the issue of bad loans in 2017.
For the banking sector as a whole, gross NPAs rose to 9.1 percent at the end of September from 7.8 percent at the end of the last financial year, according to the RBI’s Financial Stability Review released on December 29 2016. Total stressed assets in the banking sector, which also include standard restructured accounts, have risen to 12.3 percent from 11.5 percent over the six months ending September, said the FSR.
While the pace of addition to bad loans slowed in the September quarter, recoveries have also remained low.
A sudden slowdown in business in the aftermath of demonetisation could bring some additions to bad loans particularly in the small and medium enterprises (SME) segment.
In a December 16 report, Kotak Institutional Equities notes that they expect bad loans to peak by the end of the current fiscal but added that slippages (new loans turning bad) may rise if stress emerges in the SME sector.
We note that slippages and provisions may still rise if (1) further slippages were to occur in second half of FY17, especially in the SME segment as a result of demonetisation and (2) substandard assets were to slip into the doubtful category, which would require further provisioning. It may be too early for upgrades although there is some improvement in the fundamentals of stressed sectors, such as power and steel.Kotak Institutional Equities Report (December 2016)