Consolidation may Not be a Panacea for Banks’ Woes
The asset quality of Indian banks deteriorated significantly over the last three years, with gross non-performing advances (GNPAs) increasing to 9.5% as on March 31, 2017 from 3.6% as on March 31, 2014. This deterioration was sharper in public sector banks (PSBs) compared to private sector banks (PVBs), given the former’s relatively high exposure to infrastructure and steel sectors. While GNPAs of PSBs increased to 11.4% as on March 31, 2017 from 4.4% as on March 31, 2014, that of PVBs increased to 4.2% from 1.8% during the same period. As a consequence, PSBs profitability got impacted as they are required to do higher credit provisioning against these NPAs; their cumulative losses were ₹ 24,200 crore during FY16 and FY17 as against cumulative profits of ₹ 61,700 crore during FY14 and FY15. This also accentuated their need for raising fresh capital, a requirement that had already increased under the Reserve Bank of India’s (RBI’s) Basel III regulations. Following the erosion in PSBs’ earnings and capital position, domestic rating agencies have downgraded the credit ratings of 13 out of the existing 21 PSBs over the past three years. On the other hand, ratings for PVB borrowings have largely remained stable with some instances of upgrades as well. Today, only three PSBs have debt ratings at AAA as against six as on March 31, 2014, whereas only three PSBs are now rated AA+ as against eight as on March 31, 2014.
The asset quality pain for the banking sector will continue during FY18 as large quantum of vulnerable advances undergoing resolution through various scheme of stressed assets, may slip in FY18. In addition, NPAs in agricultural sector have increased post announcements of farm loan waivers. Thus overall GNPAs are expected to increase to 10.1-10.2% by March 31, 2018 (PSBs to 12.2-12.3% and PVBs to 4.54.8%). Moreover, with the RBI directing banks to increase credit provisions for accounts, where proceedings have been initiated under the Insolvency and Bankruptcy code (IBC), by March 31, 2018, PSBs’ profitability will remain under pressure during FY18 as well and possibly there may be losses for a third consecutive year too.
The scene becomes worse with the PSBs needing an incremental equity capital of ₹ 90,000-1,00,000 crore and tier-I (AT-1) capital of ₹ 20,000-40,000 crore during FY18 and FY19, respectively, to meet the regulatory norms for capital. The Government of India’s budgeted provision of ₹ 20,000 crore of capital infusion falls short and; also the windfall treasury gains of FY17, or the capital relief from revaluation of fixed assets of FY16 are unlikely to recur in the near term. Hence, many PSBs will struggle to meet regulatory capital requirements unless they raise capital from the markets.
The weak profitability and capital position are also reflected in the outlook on debt ratings—19 out of 21 PSBs currently have a “negative” outlook on their ratings from at least one of the credit rating agencies with likelihood of further downgrades over the next year. Only State Bank of India and Indian Bank have stable outlooks from all ratings agencies. Weak profitability implies banks’ AT-1 bonds (which can be serviced only through profits or accumulated profits) will see higher transition than the Tier II instruments of these banks.
In this backdrop, the success of proposed GOI’s efforts towards banks consolidation remains to be seen. At a time where many PSBs are grappling with challenges of asset quality, capital and profitability, consolidation exercise alone may not suffice. While consolidation enhances the size, it is not a panacea for woes. Past experience shows that mergers come along with a number of integration issues, which demand management attention and this may reduce their bandwidth from the ongoing NPA resolution process.
A merger of two weak banks does not lead to one strong bank in the near term. On the contrary, a weak bank merged with a similar-sized strong bank may weaken consolidated credit profile. The proposed PSBs consolidation would thus be a material event, monitored closely.