The Indian economy appears to have bottomed out with a growth of 5 per cent in 2012-13. The most conservative of growth estimates for 2013-14 is at 5.7 per cent. With the global economy gaining some traction, a new Central government in place with policy and administrative activism and hopefully with a series of good monsoons, the Indian economy should be eyeing another phase of high growth of 7-8 per cent from 2014-15. Sustained higher growth would require financing of a higher magnitude.
Commercial banks account for more than 60 per cent of the total assets of the financial system, comprising banks, insurance companies, non-banking financial companies, cooperatives, mutual funds and other smaller financial entities. A lot would depend on their capacity to finance the credit needs of a growing economy.
Are banks in a position to rise to the occasion? With migration to Basel-III norms, banks in India would need to mobilise additional equity capital to the tune of Rs 1.4 trillion in addition to Rs 2.65-2.75 trillion as non-equity capital by 2018. While SBI and nationalised banks (NBs) constitute the public sector banks (PSBs), private banks are categorised as new and old private sector banks.
The PSBs had a market share of roughly 80 per cent and private banks the rest as on March 2013. SBI has the largest market share of 19.1 per cent. Given the tight fiscal situation, PSBs have to tap the capital market to meet their capital requirement. Banks’ ability to mop up capital from the market would be governed by their profitability.
Return on Assets (RoA) is the summary indicator of profitability for banks. The profitability of new private banks (NPBs) at 1.66 per cent is more than two times that of the NBs at 0.71 per cent as on March 2013. What drives profitability of banks and why have NPBs been more profitable?
Drivers of Profitability
Profitability is governed broadly by two factors — pricing power captured through the net interest margin (NIM) and the asset quality represented through gross NPAs (GNPAs). In an attempt to understand the importance of different factors impacting profitability, the RoA data on 36 banks comprising public sector and private sector banks for 2012-13 was studied for the impact of net interest margin, GNPA and cost to income ratios. NIM turns out to have the largest positive impact on profitability, followed by a significant negative impact emanating from NPA. Operational efficiency has a positive but much lesser impact on profitability.
The better NIM and lower NPA of NPBs is due to their loan portfolio, with their relatively larger share of retail loans, which involve higher margins as well as lower delinquency. In the case of PSBs, NIMs are adversely affected by a higher share of bulk deposits, and on the asset side higher NPAs owing to the bias in the lending portfolio towards infrastructure financing — which has turned non-performing, partly due to a policy stasis for more than two years.
The outlook for NBs is tough because they are saddled with higher NPAs and large restructured assets, which will invite larger provisioning. The RBI has asked banks to increase the provisions for the existing stock of restructured assets in a phased manner over the next three years.
In addition, the provisioning requirement for fresh standard restructured advances has also increased from June 1.
All loans that will be restructured after April 1, 2015 will be classified as non-performing assets. Banks will now seek higher commitments from promoters seeking to restructure their loans.
These measures represent a significant effort to bring provisioning practices in India on par with best international practices, where no distinction is made between a restructured asset and an NPA. Stringent asset classification norms for PSBs may force them to adopt a cautious approach to business growth impinging upon their market share. Over the last four years, the PSBs have lost market share by 1.3 per cent to private sector banks.
PSBs should go for a diversified as well as well-managed asset portfolio when the next growth opportunity comes along, taking a cue from new private banks.