By Dr K Srinivasa Rao Despite the ongoing twin crisis – lingering Covid-19 and war between Russia and Ukraine, banks have gained strength in the last couple of years. The RBI’s Financial Stability Report-June 2022 reflects improved asset quality and capital adequacy ratio (CAR). The asset quality of banks continued to improve steadily with the […]
By Dr K Srinivasa Rao
Despite the ongoing twin crisis – lingering Covid-19 and war between Russia and Ukraine, banks have gained strength in the last couple of years. The RBI’s Financial Stability Report-June 2022 reflects improved asset quality and capital adequacy ratio (CAR). The asset quality of banks continued to improve steadily with the gross non-performing assets (GNPA) ratio declining from 7.4% in March 2021 to a six-year low of 5.9% in March 2022.
The GNPAs of public sector banks stand at 7.6% as against private banks’ 3.7%. More notable is the low asset quality slippage ratio (from standard to substandard) of public sector banks — pegged at 0.8% of assets against 1.3% of private banks.
The net non-performing assets (NNPA) ratio too fell by 70 bps to 1.7% during the period. The provisioning coverage ratio (percentage of funds set aside for losses due to bad debts) improved to 70.9% in March 2022 from 67.6% a year ago. The amount of loan write-off declined for the second successive year to 20% during FY22.
Though some Covid-induced stressed assets are classified as restructured loans under the RBI restructuring schemes – I and II, it does not undermine the trend. The stock of restructured loans of banks works out to one per cent under Resolution Framework (RF) – 1.0 and 1.6% under RF – 2.0. Even if all of them slip into GNPAs, the asset quality will still stand better in single digit.
The emerging asset quality trend when seen together with the launch of National Asset Reconstruction Company Ltd projects a sustained improvement of asset quality. It is expected that banks may further improve asset quality from 5.9% in March 2022 to 5.3% by March 2023 continuing the declining trend under the baseline scenario driven by higher expected bank credit growth. The reason could be the move of the corporate sector and businesses to deleverage their balance sheet and consolidate the finances.
With the newfound strengths, banks should be able to increase the flow of credit to productive sectors of the economy to hasten the revival, more importantly, the high-contact industry.
Demand for Credit
The latest RBI data indicates that the year-on-year deposit growth of banks has gone down from 10.3% to 8.3% as of June 17, 2022, while the credit growth dramatically more than doubled from 5.8% to 13.2%. Banks will have to work hard to augment deposit growth to be able to meet the increased demand for credit, failing which they may face risks of asset-liability mismatch. Another challenge is the rise in the cost of resources and hardening bond yields due to the RBI approach to absorb excess liquidity from the markets to tackle the inflation beast. After declining continuously for the last two years in tune with easy monetary and liquidity conditions, the cost of funds and yield on assets have started looking up.
The share of credit flow of banks to large borrowers has been declining in recent years, indicating a reduction in credit risk concentration and diversification of borrowers. A large borrower is defined as one who has aggregate fund-based and non-fund-based exposure of Rs 5 crore and above reported to RBI under CRILC. The demand for credit by large borrowers is increasing with the revival of the economy and government focus on capex and infrastructure spent.
With interest rates going up across the globe to fight inflation, the corporate sector may find it difficult to explore the overseas route to access funds. External commercial borrowings (ECBs) are turning costly and the economy is experiencing a flight of foreign portfolio investments (FPIs) exerting pressure on the rupee which has already breached the Rs 78-mark against the dollar. However, with the RBI easing rules, things may look up. Also, due to changed macroeconomic factors and persisting geopolitical risks, the corporate sector is looking back at domestic banks to fund their needs.
Banks have ostensibly built resilience to improve lending appetite linked to rising capital to risk weighted assets ratio (CRAR). Improved performance of banks facilitated raising capital and earnings retention that supported capital augmentation. The CRAR has been on the rise since March 2020, improving to 16.7% by March 2022. The CRAR of public sector banks stands far above the minimum needs at 14.6% while private and foreign banks could muster a CRAR of 18% demonstrating good lending capacity.
The stress test of RBI indicates that no bank would slip below the regulatory benchmark of 11.5% of CRAR. They have built robust profitability and better fundamentals during FY22 to attract capital despite adverse market conditions.
In the realm of improved profitability, the net interest margin (NIM) – difference between interest income generated and the amount of interest paid out to lenders — of banks increased marginally to 3.4% during FY22. The NIM of public sector banks stands at 2.9% while that of private banks is at a high of 4.1%. The average return on assets of all banks works out to 0.9% — public sector 0.5% while private banks’ is at 1.4%. The return on equity is at 9.7% — 7.9% for public sector banks and 12.2% for private banks. These sound fundamentals attract better market sentiments.
The revival of the economy is picking up with industry preparing to operate under elevated input costs with higher inflation becoming a global phenomenon. Though inflation in India eased to 7.04% in May from 7.79% in April, it continues to be far above the target of a flexible inflation targeting framework. The better part is the reducing supply-side disruptions with many economies resuming activities in full swing after the Covid disruptions.
The continued focus of the government on capex spent and infrastructure should further induce demand for credit. A better monsoon outlook and the corporate sector looking for expansion and diversification opportunities may add to the buoyancy. Better growth signs amid disruptions and downside risk reflect the resilience of the industry.
With the pandemic almost turning into endemic, the consumer psyche to restore demand for goods and services is looking good. The renewed demand should lend support to industry to cope with the lingering geopolitical risks and rising inflation. The stronger outlook of banks comes just in the nick of time when the demand for credit is inevitable to provide the much-needed adrenaline to the economy.