Tuesday, January 18, 2011

2011: Indian Banking Sector Outlook.

Q: You have seen many of these phases in the past, given how sharply deposit rates have moved in the last few weeks, is it conceivable that banks margins might come under pressure?

Purwar: Temporarily yes. Right now, for example the credit interest rates revision for obvious reasons cannot be pushed beyond a point. Banks would like to take a little time before doing that. For the present, the margins will be under pressure in the short run, but in the medium to long-term, banks will see to it that margins are protected and maintained. If the deposit rates go up, naturally, the credit rates, the interest rates will go up as well.

Q: Having gone through these kinds of rising interest rates, rising inflation scenarios in the past, how do banks particularly public sector banks do in such environments?

Narang: When the interest rates go up, fact is profits of the banks go up because the interest rates in advances also go up. There might be a little time lag but at the end of the day the bank is a gainer. Where the bank loses is higher risk therefore, higher provisions on account of increased NPAs. An interest rate hike is not going to have a deep impact on the NIMs. Interest rate hikes will have deep impact on the ultimate profit of the bank.

Q: When you say you expect to see some kind of temporary hit on margins for banks, how long would that period be in your experience? When this interest rate cycle moves and you see deposit rates moving higher how many quarters does it take before things stabilise?

Purwar: No. It won’t take a quarter. Maybe bankers would like to see how things progress for maybe a month or two and they would then announce a hike in the interest rates. One other implication of this rise in interest rate which we should take note of is that whenever the interest rates are going high then the treasury portfolio of the bank, normally, the larger profits are required to be made on the investment portfolio of the bank. There the bankers get hit.

In the medium-term and in the long run, sometimes, the hike in the interest rates has some sort of adverse impact on profits maybe for a year.

Q: Along with the trend of rising rates, there is tremendous liquidity shortage as well right now in the system. That is pushing short-term rates up quite a bit. How tough is that for a bank to deal with?

Narang: As of date, there are two serious issues which the banks are facing. Inflation rates going up that means interest rates have to go up. When the State Bank raised their rates of interest to 9.5% for 10-year bond, it was a clear message to the market that interest rates in India are understated. There is a potential for them to go up.

The second part is liquidity. As on date, banks are borrowing anything between Rs 80,000 to 100,000 crore from the RBI on a daily basis. The RBI has to address these two issues. One is addressing inflation and the other is addressing liquidity. The policy proclamation on these two fronts will be very clear and will be very firm otherwise markets can go out of hand.

Q: If you could come in on that point Narang mentioned about slipping asset quality and higher provisioning because of NPA concerns in this environment. Do you see that as a legitimate concern?

Purwar: Absolutely. When such high inflation rates are there, interest rates start going up. A very normal impact is as far as the good customers are concerned that is fine with them, they are able to bear the burden of higher cost of interest. But as far as the marginal customers are concerned, a hike in the interest rates means a deeper dent on their pockets.

That is where these marginal accounts start slipping into the non-performing categories. That is where the problem starts. The assets start becoming bad, substandard and doubtful. Progressively higher and higher provisioning is warranted. That is one important challenge which the banking system will have in this year and more particularly next year.

Q: In a scenario where credit growth is very robust, do you fear given this kind of a inflation interest rate scenario, growth could slip and therefore, credit growth is not a strong as bankers expected to which will enable them?

Narang: I have absolutely no such fear. Rather I expect, this year the growth of deposits to be very robust, for the simple reason that there is a terrible amount of redemptions in the mutual fund market. Wealth management is as it is in disarray and interest rates are going to be very high. So fixed income securities are going to be the flavour of the season. I do not see any problem in the growth as far as the deposit is concerned.

In India, there is a normal growth of about 10-12% from the existing businesses. Garnering another 10%, in such a beautiful investment climate is not going to be an issue. Growth of the banks is not going to be an issue at all. On the contrary, I see a robust growth coming next year.

Q: One issue specific to public sector banks that have not been talked about that much is the change in pension norms and the kind of provisioning banks will now have to make because of the SPO and what happens to the increased gratuity limits. Is that a very real problem for public sector banks this year? How much do they need to detail for employee cost and pension liabilities?

Purwar: For pension liability, the current norms which have been put in place would require a very substantial provisioning on the part of the banking system. The exact amount is very difficult to estimate but with the way things are, it should be a pretty hefty sum. Those provisions would be required to be made out of profits of the current year. So that is a very important expenditure item.

Q: I am just running estimates that people are talking about which range between 15-20% in terms of a hit on earnings. Would you say that the potential impact for public sector banks?
Purwar: Yes. It could be a little more also.

Courtesy: http://www.moneycontrol.com/news/business/2011-how-willyear-pan-out-for-banking-sector_513295.html

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