The Hindu Business Line : Will there be surprises in our bank balance sheets?

What’s common between cricket players and central bankers? They keep us on the edge of our seats, and can surprise us all the time. Tuesday was one such day, when the Reserve Bank of India (RBI) announced yet another round of rate cuts, sending a clear message to banks that they should follow suit by reducing their lending and deposit rates to support the return of the economy to a higher growth path.

No different, in a way, from a star batsman in a T-20 match who can set the pace with aggressive scoring, and thus often unrealistically raise the spectators’ expectations that the rest in the team would follow his model.

Whilst the rate cuts are, at best, a signal from the RBI on its intent to see lower rates in the system, the RBI has stressed on developing a corporate bond market as well as rationalising the Government borrowing programme to keep interest rates lower, observed Mr Abizer Diwanji, Head of Financial Services, KPMG, interacting with Business Line by e-mail, soon after the monetary policy announcements.

On the bank balance-sheet side, ATM delicensing will improve banking efficiency considerably and improve overall cost-income ratios, he added. “A move towards consolidation of NPLs (non-performing loans) in an SPV (special-purpose vehicle) for onward sale to ARCs (asset reconstruction companies) would further help the efficient use of capital by banks.”

Excerpts from the interview:

Will we be seeing major surprises in our bank balance sheets for the just-ended fiscal?

Surprises, generally, are reactions from the less-informed. What we would see different, compared to earlier years, are the following:

Lower net interest margins, as incremental liquidity has primarily been invested in low-yielding but less risky sovereign paper.

High level of NPLs out of real estate, retail assets, and SME (small and medium enterprise) books, mainly due to the meltdown.

Significant technology spend in the prior year, coupled with rationalisation of processes, infrastructure and systems, have resulted in lower costs (reflected by better cost-income ratios).

High treasury gains mainly due to the slackening of interest rates in Q4.

What strategies would you recommend to corporate CFOs, in view of the flux that the financial world is continually witness to? Also, what have been the harsh lessons that our CFOs learnt during 2008-09?

Frankly, CFOs (chief financial officers) need to reassess their business plans in the current environment. Until the end of 2008, most company plans were growth-oriented, with positive cash-flows and an assumption of availability of capital to fund all-round growth. These are times of scarcity of funds and paucity of demand. Though cost-cutting measures have been initiated, companies would need to strategise managing the turnaround and work around repayment commitments.

This would involve identifying growth areas, cash generation (non-core disposal, debt-refinancing and capital-raising), and conservation opportunities. This would also require companies to take their bankers into confidence to work out financial viability of these plans. Importantly, these need to be done much before the companies slip into a stage of no return. Promoters need to help their managements by making their expectations more realistic.

With great untapped potential in Indian banking, what specific policy measures will bring in more to the banks’ bottom-lines?

Different banks have different potentials. Public sector banks are best suited to exploit their CASA (current account/savings account) customers for retail products by mining their banking behaviour. They have the reach and the right cost of funds to profitably manage the transition. I personally think NPL resolution would go a long way in releasing the required capital for banks. The reason why NPLs remain unresolved is mainly due to disputes among bankers to a corporate, and a general lack of systems support to resolve.

Public sector banks should consider transferring NPLs to an SPV, so as to enable aggregation and then onward sale to an ARC. Aggregation would fetch a better price for exposures and yet leave enough room for ARCs to make profit on resolution. Similarly, retail NPL resolution could convert toxic assets on bank books to cash.

Infrastructure lending is the third big opportunity for banks. However, this will happen only with some guarantees from the Government initially. Fuelling of infrastructure spend through financial closure of large projects would not only stimulate infrastructure companies but also improve cash flows of dependent companies. Better corporate earnings will spur demand growth.

Where are the cost inefficiencies in Indian banking that need urgent attention?

Cost-income ratios in the Indian banking sector have improved significantly, thanks to technology and innovative distribution channels. However, the future of banking would be in cutting operational costs by automating branch banking.

The RBI, in the Credit Policy, has taken a significant step by delicensing ATM set-ups. Banks will now be able to spread reach without the necessary branch infrastructure. Also, outsourcing ATM management will make these costs variable for banks.

Your views on consolidation in the financial services space...

Consolidation without integration would not be beneficial to the system. As we have seen in the past, public sector banks need to be able to integrate well. There is a clear need to consolidate them, given the growth capital needs, but there will be redundancies and branch closures as a result.

As regards the private sector banks, there are the weaker banks which could be taken over by the stronger ones. Here, the regulator should be open to foreign banks or even strong NBFCs (non-banking financial companies) as potential acquirers, as they would find the opportunity more attractive. Local banks may not want to acquire local banks, as servicing capital would be an issue; and with liberal licensing the need to acquire and integrate is not considered commercially viable for most.

In what ways is our approach to rates and financing different from that of other countries which are similarly battling slowdown/ recession?

India is still regulated in terms of capital account flows. Accordingly, rates are very much dictated by the regime. Also, with public sector banks still comprising a large part of our banking system, implementing a regulated rate is a possibility, given the Government’s objectives, which are not fully commercial. Further, liquidity in India is tightly managed. Our advances-deposits ratios are in the range of 50 per cent, as against 98 per cent in the US and above 100 per cent in Europe. Government debt, at Rs 13 lakh crore, comprises 28 per cent of our GDP. These factors help the regulator keep a tight grip on liquidity. Accordingly, bank rate, repo rate, and securities auction rates, have a bearing on commercial lending rates.

In other markets, where the problem of toxic assets is more systemic, the governments have either moved the assets out, or supplemented lending to fuel demand.

A healthy corporate bond market too enables right pricing of credit. The only option to lower rates is to offer government securities at low rates to finance deficits out of stimulus packages.

In India, liquidity has been curtailed but we are yet to see credit move to corporates, for which the Government will need to supplement credit risk. Our toxic asset levels have not reached systemic proportions and hence do not require a specific incentive package.

India needs to develop a corporate debt market with demand being created by market makers (both Indian and foreign). This will right-price credit and make credit delivery more efficient.

D. MURALI

AccountSpeak.blogspot.com

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