How strong our banks are? What is the need of the hour

How strong our banks are? What is the need of the hour based on RBI's Financial Stability Report for SEPT-2017.

Banking is a backbone of the country and their strength reflect the strength of the country and its rating in the international market. A better rating by the Rating agencies viz. Moody, Standard and poor, will help the country, its corporate and financial institutions to raise funds from the international market at a cheaper rate.

RBI has released the financial stability report for the half year ended Sept 2017 wherein they have vividly brought out the issues faced by the financial system in India. We will take the Banking sector report and understand the strength of our banks.

Business growth

The deposit of all SCBs on a year on year basis has decreased from 11.1% to 7.8 % between March and September 2017. The reason may be the demonization factor which helps the Bank with the flood of deposit in the month of Nov and Dec 2016. 

The credit growth on the same period increased from 4.4% to 6.2 % and the public sector banks recorded growth of 0.7% to 2.2 % reversing the declining trend of past years.

It may be noted that the Foreign Banks has registered a negative growth during the period ending Sept 2017 both in deposit and loan portfolio.

Soundness – Capital adequacy and leverage ratio

Capital to risk-weighted asset ratio (CRAR) of SCBs increased from 13.6 percent to 13.9 percent between March and September 2017 largely due to an improvement for private sector banks (PVBs). The CRAR is almost stagnant at 12.2% due to the laxity of the Government to induct additional capital and now only the finance ministry has proposed to infuse additional capital for the Banks. All the Banks should achieve a minimum CRAR of 11.5% by Mar 2019 as per Basel III. However, the banks which fall under the category of too big to fail must have an additional capital requirement of 2.5%.

Asset quality  

The asset quality of a bank plays the very important role as it is the main factor which affects its health, profitability, and efficiency of the bank. The main factors in the asset quality are classified into Gross Non-Performing Asset (GNPA), Restructured Standard Advance (RSA) and Stressed Advances (SA) and Net Non Performing Assets as all these are interconnected.

For the Indian banks, the GNPA ratio of SCBs increased from 9.6 percent to 10.2 percent between March and September 2017, whereas, their RSA ratio declined from 2.5 percent to 2.0 percent. The SA ratio rose marginally from 12.1 percent to 12.2 percent during the same period. GNPA ratio of PSBs increased from 12.5 percent to 13.5 percent between March and September 2017. Stressed advances ratio of PSBs rose from 15.6 percent to 16.2 percent during the period

The GNPAs of all SCBs has increased by 18.5 percent on a y-o-y basis in September 2017. PVBs registered a higher increase in GNPAs (40.8 percent) as compared to their public sector counterparts (17.0percent)

Net non-performing Assets

The net non-performing advances (NNPA) as a percentage of total net advances increased from 5.5 percent to 5.7 percent between March and September 2017. PSBs recorded distinctly higher NNPA ratio of 7.9 percent

 NNPAs of all SCBs increased by 11.1 percent on a y-o-y basis in September 2017

Sector-wise asset quality.

The asset quality of SCBs deteriorated across broad sectors between March and September 2017 with the industrial sector leading this cohort, among the major industry sub-sectors, mining and quarrying, food processing, engineering, construction, and infrastructure registered an increase in their stressed advances ratios between March and September 2017. The asset quality of sub-sectors such as textiles, rubber, cement, basic metals, and vehicles, however, improved during the same period. It is evident that most of the NPA come from basic metal and infrastructure sector.

Credit quality of large borrowers

The share of large borrowers both in total SCBs’ loans as well as GNPAs declined between March and September 2017.  The total stressed advances of large borrowers increased by 2.4 percent between March and September 2017. Advances to large borrowers classified as special mention accounts also increased sharply by 56.5 percent during the same period.  

The GNPA ratio of large borrowers increased from 14.6 percent to 15.5 percent between March and September 2017. The GNPA ratios went up for both PSBs and PVBs, whereas, the same came down for foreign banks (FBs). The share of standard advances (excluding restructured standard advances) in the total funded amount outstanding of large borrowers declined from 80.9 percent to 80.6 percent between March and September 2017. The top 100 large borrowers (in terms of outstanding funded amounts) accounted for 15.5 percent of credit and 25.0 percent of GNPAs of SCBs

Stress Testing -- NPA

The stress test indicated that under the baseline scenario, the GNPA ratio of all SCBs may increase from 10.2 percent in September 2017 to 10.8 percent by March 2018 and further to 11.1 percent by September 2018. However, if the macroeconomic conditions deteriorate, the GNPA ratio may increase further under such consequential stress scenarios.

Under the assumed baseline macro scenario, six banks have CRAR below the minimum regulatory level of 9 percent by September 2018. However, if the macro conditions deteriorate, CRAR of more banks in the stress test goes below the minimum regulatory requirements. Under the severe stress scenario, the system level CRAR declines from 13.5 percent in September 2017 to 11.5 percent by September 2018. The recent capitalization plan announced by the GoI for PSBs is expected to significantly augment capital buffers of affected banks as also the credit growth

Stress test – Interest rate Risk

For investments under available for sale (AFS) and held for trading (HFT) categories (direct impact), a parallel upward shift of 2.5 percentage points in the yield curve will lower CRAR by about 123 basis points at the system level. At the disaggregated level, four banks accounting for 5.3 percent of the total assets were impacted adversely and their CRAR fell below 9 percent. The total loss of capital at the system level is estimated to be about 10.3 percent. The assumed shock of a 2.5 percentage points parallel upward shift of the yield curve on the held to maturity (HTM) portfolios of banks, if marked-to-market, reduces the CRAR by about 280 basis points resulting in 19 banks’ CRAR falling below 9 percent.

Liquidity risk

Scenarios, there will be increased withdrawals of uninsured deposits Simultaneously, there will also be increased demand for credit resulting in an attempt to withdraw unutilized portions of sanctioned working capital limits as well as utilization of credit commitments and guarantees extended by banks to their customers.  Using their HQLAs required for meeting day-to-day liquidity requirements, most banks (49 out of the 54 banks in the sample) remain resilient in a scenario of assumed sudden and unexpected withdrawals of around 12 percent of deposits along with the utilization of 75 percent of their committed credit lines

Credit concentration risk

Credit risk arising from exposure to the infrastructure sector (specifically power, transport, and telecommunications) was examined through a sectoral credit stress test where the GNPA ratio of the sector was assumed to increase by a fixed percentage point impacting the overall GNPA ratio of the banking system. The results show that shocks to the infrastructure segment will considerably impact the profitability of banks, with the most severe shocks (15 percent of restructured standard advances and 10 percent of standard advances becoming NPAs and moving to the sub-standard category) wiping out about 87 percent of the profits. The most significant effect of the single factor shock appears to be in the power sector

Conclusion:

The credit growth has improved during the 6 month period ended Sept 2017 but the growth does not commensurate with the economic growth of 5+% of the country. Either the banks deliberately keep the credit growth under control to maintain the quality of the credit portfolio or divert their resources to reduce the NPAs.

The NPAs are on the rise due to the policies of the government and inefficiency of the Bank to take advantage of the legal system. Despite the creation of DRT, Sarfaesi act etc, the recovery percentage of NPA is poor. Therefore, we need to look into the process and take corrective action. It is also observed there is the sudden rise in NPA during the last year and also current half year in private sector/ public sector banks is due to suppression of NPAs and provisioning to present a better balance sheet and lack of supervision of the regulator over the banks and the financials. Lack of knowledge in managing the credit portfolio is also evident.

The banking system is managing the interest rate risk well although a shock of 2.5 % upward shift will reduce around 280 basis points CRAR and 19 banks CRAR will fall below 9 % mark.

The liquidity risk is under control.

The need of the Hour

Let is wait for the Government program to augment capital of the Public sector banks which will improve the risk perception of the bank. The need of the hour is to control the NPAs and speedy recovery of the same. Although there is accountability at the lower level, it is high time to consider accountability at the top management level also as the major chunk of the NPAs are from the large borrowers.

Under universal banking, it is necessary to provide all products including insurance, credit cards, and mutual funds to the customer under one umbrella. At the same time, the core business of banking viz. accepting deposit and quality lending should not be pushed to back seat. 

This is based on the RBI report on Financial Stability report for sept 2017  all graphical representation are from the same report.(www.RBI.ORG.IN)