Tag: risk aversion

Bad bank should have been set up 3-4 years back, not now: Kotak Securities report

Banking & Finance

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Establishing a bad bank today would aggregate but not serve the purpose that has been observed in other markets, Kotak Securities Ltd (KSL) said in a report.

Bad bank is perhaps well served in the initial leg of the loan recognition cycle, it added.

“While we are unaware of its probability and design, creation of a bad bank would have been most fruitful three-four years back (perhaps just after the Asset Quality Review) or earlier when the stress was just building up and banks were looking to delay recognition for various reasons.

“Today, the banking system is relatively more solid with slippages declining in the corporate segment for the past two years and high NPL (non-performing loan) coverage ratios, which enable faster resolution,” said KSL analysts M B Mahesh, Nischint Chawathe, Abhijeet Sakhare, Ashlesh Sonje and Dipanjan Ghosh.

Also read: Kotak Securities launches start-up investment and engagement programme

Based on insights gained from two key reports of BIS and IMF, the report observed that a successful bad bank needs a critical mass (healthy buy-in from lenders) of impaired assets, robust legal framework for debt resolution, along with strong commitment to reforms.

The analysts observed that segregation of impaired assets without sufficient recapitalisation has insignificant impact on future loan growth and NPL creation. A bad bank is expensive to establish, needs a well-defined mandate, and clear exit strategy.

Further, timing of formation and pricing of assets are crucial as the objective is to release stress from lenders early in the cycle so that they can refocus efforts in creating credit. Finally, there are instances of bad banks not achieving their desired objective, the analysts said.

After nearly a decade of elevated slippages, FY2019-20 saw a much lower slippage trend with evidence of it moving closer to normalisation before the impact caused by Covid-19, the report said.

The analysts said they are yet to assess the impact of Covid-19 but in their view the corporate portfolio appears to be holding quite well.

Also read: Rate of decline in fresh lending and deposit rates slows down: Report

Public sector undertaking (PSU) banks PSU, in particular, have gone through this with fresh equity (about ₹3.5-lakh crore over FY2016-21 by the government/Life Insurance Corporation of India) in the past three years and provision coverage ratio (PCR) improving to about 70 per cent from about 40 per cent in the past three-four years.

“A high coverage ratio ensures that faster consensus building is also no longer an issue. We have seen the introduction of IBC as well as consolidation in public banks. We had limited systemic risk from a liability perspective,” the analysts said.

The report observed that one of the key objectives of segregating impaired loans is to restore faith in bank balance sheets and help unlock funding market access. However, PSU banks control a large part of the banking system with a high contribution to NPLs.

“Managerial incentives across organisations are probably still fully not aligned to maximising value through early recognition of bad loans,” the analysts opined.

Also read: Kotak Securities launches platform for buying US equities

Further, given the high contribution of retail deposits, funding stability of these banks is uncorrelated with their financial performance for an extensive period of time.

The analysts said lack of credit growth, especially in the corporate segment, is often attributed to PSU banks’ risk aversion (low capital/high NPLs in the past).

“However, we do argue that corporate deleveraging has been quite slow and credit demand, especially by the better-rated and large wholesale borrowers, has been slower,” they added.

The behaviour of PSU banks has been different with respect to retail and micro, small and medium enterprise (MSME) lending, as these banks have been helping credit growth, especially in recent years and much higher than trend levels post the Covid-19 outbreak.

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Sitting on a pile of deposits, players battled both risk aversion and lower credit offtake

Banking & Finance

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Nothing could have prepared the banking system in India to deal with a black swan event like the Covid-19 pandemic, which unfolded even as the economy was in the throes of a slowdown.

The Calendar Year (CY) 2020 saw Indian banks grappling with multiple challenges, including tepid credit demand as the country went into lockdown mode for the major part of the second quarter (April-June) in an effort to curb the coronavirus; copious deposit inflows due to flight to safety; and the risk aversion that set in due to fear of default by borrowers.

RBI: Heavy lifting

The Reserve Bank of India (RBI) did some heavy lifting to keep the financial system stable, announcing a host of measures to ensure that adequate liquidity is available to all constituents so that Covid-19 related liquidity constraints are eased.

To ease financial stress on businesses and households, the RBI permitted lenders to offer moratorium on term loan instalments, deferred interest on working capital facilities from March 1, 2020 to August 31, 2020, and eased working capital financing.

The year also saw a dramatic rescue of two private sector banks — Yes Bank and Lakshmi Vilas Bank (LVB) — whose financial position had undergone a steady decline.

 

Yes Bank was rescued by eight financial institutions led by State Bank of India, who collectively pumped in ₹10,000 crore capital. LVB was merged with DBS Bank India Ltd, a wholly owned subsidiary of DBS Bank Ltd, Singapore.

The government pressed ahead with consolidation in the public sector banking space, amalgamating 10 PSBs into four with effect from April 1, 2020.

According to the Finance Ministry, the consolidation would enable investments in technology, better customer reach, wider array of products and services, enhanced lending capacity and improved operating efficiency.

Credit growth down

Credit growth lagged deposit growth in CY2020. The slowdown that India has been witnessing since Q1 (April-June) FY19 was exacerbated by the deleterious impact of the pandemic on lives and livelihood.

Credit growth slumped to 4.46 per cent from January 3-December 4, 2020 period as against 6.66 per cent in the January 4-December 6, 2019 period.

Referring to the asset quality concerns, CARE Ratings, in a presentation on the banking sector, observed that banks have been being very selective with their credit portfolios.

However, the overall bank credit growth has been backstopped by disbursements under ECLGS (Emergency Credit Line Guarantee Scheme), which has been extended further till March 31, 2021. “Moreover, as on December 4, 2020 the liquidity surplus in the banking system stood at ₹5.8 lakh crore.

“The liquidity surplus can be ascribed to deposit growth outpacing credit growth persistently,” the agency said.

CARE expects the banking system liquidity to remain in a surplus position aided by sustained growth in bank deposits as against slower growth in the bank credit.

To address liquidity issues being faced by non-banking finance companies (NBFCs) as well as the concerns of banks regarding credit defaults, the Government and the Reserve Bank of India (RBI) unveiled Partial Credit Guarantee Scheme and Targeted Long-Term Repo Operations (TLTRO), respectively.

The RBI encouraged banks to synergise ECLGS 2.0 and On Tap TLTRO by availing funds from RBI under TLTRO and seek guarantee under ECLGS to provide credit support to stressed sectors (identified by the Kamath Committee).

Deposit growth up

Deposit growth was up at 10.23 per cent per cent in the January 3-December 4, 2020 against 9.40 per cent in January 4- December 6, 2019.

The surfeit of deposits prompted banks to cut the term deposit rate (over 1 year) to 4.90-5.50 per cent (average) as on December 11, 2020 against 6.20-6.40 per cent as on December 13, 2019, according to RBI data.

Along with the deposit rate cut, which came amid surplus liquidity in the banking system and weakening credit demand, the lending rates, too, declined. For example, State Bank of India’s external benchmark rate declined from 7.80 per cent as on January 1, 2020 to 6.65 per cent now. Its one-year marginal cost of funds based lending rate (MCLR) too declined from 7.90 per cent to 7 per cent in the last one year.

ICICI Securities, in a report, said: “Evaluating macro-economic variables including trends in private/ government capital expenditure, aggregate demand, high frequency lead indicators, year-to-date trends of credit flow, and corporate/ government/ consumer ability to spend, we pen down credit growth estimate at 4.4 per cent for FY (Financial Year) 21E (Ending), 9.5 per cent for FY22E and significant spike to 13-15 per cent over FY22-25E.”

The RBI announced liquidity measures aggregating about ₹12.7-lakh crore since the February 2020 policy.

‘Avoided recession’

As per RBI Executive Director Mridul K Saggar’s observations in the minutes of the monetary policy committee meeting: “This large liquidity infusion served an important role in preventing meltdown of markets in Q1 of 2020, reversing the spike in financial spreads observed in March, averting acute credit crunch, thwarting tightening of financial conditions that could have plummeted economy into a deep recession with its domino effects on financial stability that could have further complicated policy choices.”

To tackle negative surprises, if any, on the asset quality front, banks stepped up bad loans provisioning in the last two quarters even as they moved to bolster capital levels through qualified institutions placement.

S&P Global Ratings has cautioned that the Covid-19 outbreak has heightened stress levels and uncertainty across the Indian banking system.

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