Thursday, January 29, 2009

More banking sector observations

In continuation to the previous post, here are a few more observations on the banking sector

1. The graphic below indicates that the private sector and foreign banks have been more reluctant to pass on the benefits of the RBI rate cuts. Interestingly, the domestic private banks are more conservative in their lending rates than even the foreign banks, whose reactions may be partially explained by the problems faced by their parent banks in US. Further, the lending-deposit rate differentials for private banks is 6.75-8%, almost double that of the 3.75-4% for public sector banks. If despite these margins and cushions, the private sector banks have seen higher growth in NPAs relative to the public sector banks, then it raises questions about their competitiveness and operational performance. Does it mean that the public sector banks in India are more efficient, atleast to the extent of the core banking activity of managing lending and deposit taking?

2. The foreign and domestic private sector banks also appear to have suffered a crisis of confidence among depositers. This is indicated by the sharp drop in growth in their deposits compared to their public sector counterparts. The deposits grew by just 12.1% and 13.4% for foreign and private banks respectively in 2008, as against 34.1% and 26.9% repsectively for 2007. In contrast, the deposit grew at the same 24.2% in both years for public sector banks. Does this mean that like in the US, when the times were good, the former engaged in less than prudent practices like offering more than sustainable deposit rates to attract deposits?

3. There is some validity in the reasoning by banks that they are constrained in their ability to lower depsoit rates, especially given the need to shore up reserves in these uncertain times. Banks can lower their lending rates only if they lower their deposit rates commensurately. However, the prevailing high interest rates on small savings instruments like Public Provident Fund (PPF), at 8%, puts a clear floor on lowering deposit rates. In the circumstances, if banks lower deposit rates more aggressively, there could be a flight of deposits from banks to these instruments and similar others like post office savings accounts.

4. Announcing the quarterly credit policy review, the RBI Governor made a direct mention of the fact that the "transmission of the policy interest rate signal" while effective in the money and government securities market, has failed in the credit markets. Since October 2008, the RBI has reduced repo rate from 9% to 5.5%, reverse repo rate from 6% to 4%, and CRR from 9% to 5%, all of which coupled with liquidity injections have released Rs 3,88,045 Cr into the banking system. Despite such extraordinary measures, the credit markets remain trapped in the high rate vortex.

Update 1

The Businessline reports that banks have delivered impressive profit growth in the December quarter, with the average net profit growth for the top-20 banks standing at 58% and a median net profit growth standing at 44%, riding on higher treasury income (as yields fell, bond portfolios appreciated in value and mark to market losses were written back), higher margins (due to the CRR cut and lower provisions, which are freed up for lending), and still high lending rates. Further, the Net Interest Margins (NIMs) of these banks are also at a very healthy, even unsustainably high, range of 3-4%. These figures would appear to indicate considerable comfort and cushion for these banks to lower their lending rates.

The one standout looks to be ICICI. Despite profitting from a sharp boost in their treasury income (it rose to Rs 976 crore against Rs 282 crore last year), the Y-o-Y profits grew just 3.4%, against the sector average of 58%. Add in the fact that its NIM is also relatively low at 2.4%, and the NPAs have registered a relatively larger increase. Do we have some cause for concern?

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