Past excesses come back to haunt Indian banks

BANKS are once again under spotlight. Not the kind of spotlight you would see at an awards ceremony. More likely the kind you would see in an interrogation room perhaps. This is true not just in India, where banks have reported a sharp deterioration in earnings, but also globally, where the stability of large global banks is again being scrutinised. Different issues besiege banks in different geographies ranging from India to Europe, but dealing with past excesses appears to be the common thread. Let's look at what is happening here in India. A few weeks back, this column argued that it's time for banks to come clean and stop disguising stressed assets. That is now the clear message from the Reserve Bank of India (RBI) and banks need to toe the line. Well, that process has now started and the outcome is not looking pretty. Until mid-day on Thursday, 11 February, 26 of the 39 listed banks had reported earnings. For this set of banks, the gross nonperforming assets (NPAs) have jumped 27% between the September- and December-ended quarters toRs.2.72 trillion from Rs.1.90 trillion. Provisions have surged more than 72% quarter-onquarter (q-o-q) for this set. (Note: A q-o-q comparison is more relevant in this case because it tells you the extent to which bad loans were under-reported and the inadequacy of provisioning. Both are now getting corrected following the RBI's asset quality review.)

While the aggregate jump in bad loans is worrying enough, some of the mid-sized banks have reported real howlers. The country's largest lender, State Bank of India (SBI), reported a 28% increase in gross bad loans between the third and fourth quarters and an 82% uptick in provisions. Profits fell 62%. Arundhati Bhattacharya, chairperson of SBI, warned that a further hit may need to be taken in the fourth quarter. However, Central Bank of India, Dena Bank, Allahabad Bank and Indian Overseas Bank, have all reported large losses as the increase in provisions completely wiped out profits. Punjab National Bank (PNB) managed to report a small profit because of tax write-backs. If not for that, it, too, would have reported a loss. Among private sector banks, the big shock came from India's largest private sector lender, ICICI Bank Ltd. It reported a 33% increase in gross NPAs between the September and December quarters. Its gross NPAs, as a percentage of total loans, is at 4.72%. What is worrying is that not all banks have taken the entire hit from RBI's asset quality review in the third quarter, which means there will be more pain in the fourth quarter earnings.

Investors are worried about what is to come and have beaten down bank stocks mercilessly. But along with looking ahead, it is worth looking in the rear view mirror to remember what got us to this point and apportion blame appropriately. There are three primary excesses that have led us to this pass. First, banks in India, like elsewhere, had lent excessively to commodity driven sectors forgetting that commodities are susceptible to wild swings. In this case, while bankers must be faulted for not exercising due prudence in lending to volatile sectors and highly leveraged companies, you can probably offer them some sympathy. The lending happened when the commodity super cycle was on an upswing and the fierceness with which it reversed caught everyone by surprise. Second, banks went overboard on lending to the infrastructure sector in support of the attempt made by past governments to push infrastructure growth in India.

In the absence of a strong corporate bond market, banks were funding projects they had no real capacity to fund and also taking on risks that they didn't really understand. Here the blame must be split down the middle between governments rushing the process and bankers yielding to that pressure. According to RBI's December financial stability report, five sectors-mining, iron and steel, textiles, infrastructure and aviation, constituted 53% of the total stressed advances across sectors. Third, and most damagingly, banks continued to lend to promoters and entities that were already highly leveraged and even some who did not have a good track record of repayment. Crony banking is the only way to describe this. Here, banks must take 100% of the blame. According to a July 2015 report from UBS, loan approvals to potentially stressed companies have risen 85% since 2011-12 as banks continued to lend to such borrowers despite deteriorating cash flows and increased debt on their balance sheets. Bankers must bear the cross for this and they are.