Public sector banks -- Out of credit in the stock market

N. S. Vageesh

PUBLIC SECTOR bank stocks simply have no credit at the bourses. Listed banks comprise only nine of the 27-strong group.

Market interest, however, has remained confined (according to the regulators, a ``skewed'' trading pattern) to only three stocks -- State Bank of India (SBI), Corporation Bank and Bank of Baroda. Even this seems to have evaporated, if the beating these stocks have taken over the past year is anything to go by.

The SBI stock fell from a high of Rs 278 in early January to a low of Rs 155 in October, and is now a shade higher at Rs 172. Over the same period, Corporation Bank fell from a high of Rs 125 to Rs 55 mid-May. It is now trades at Rs 84. The Bank of Baroda stock fell from Rs 68 to Rs 34 and has been stagnating at Rs 40-45 for quite some time. The traded volumes in these stocks also declined steeply.

Bank stocks have traditionally been considered `widow's shares' -- those that yield steady, but not high, returns. Until a decade ago, fluctuations in bank profits were rare or remained in a narrow band with the help of secret reserves (before the advent of prudential and disclosure norms).

The logic underlying the use of such reserves was that volatility in bank profits from year to year would lead to a loss of public confidence in the banks. This confidence was vital because at the core of banking operations lay the ability to take risks with customers' money.

At the crossroads

The liberalisation of the financial sector, and the introduction of new accounting and disclosure practices (still in progress) coincided with the opening up of the economy. The hitherto protected domestic manufacturing industry was exposed to competition and is going through a painful restructuring process.

Credit risk, sickness, non-performing assets all, suddenly became dominant in the banking lexicon and overshadowed the earlier emphasis on deposit mobilisation and branch expansion. Indian banks were no longer immune to the violent fluctuations in profits. Their stocks consequently began displaying similar gyrations.

Profits of 27 public sector banks rose from Rs 3,152 crore in 1996-97 to Rs 5,029 crore in 1997-98 before declining to Rs 3,258 crore in 1998-99. However, profits grew 57 per cent to Rs 5,117 crore in 1999-2000.

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The performance in 1999-2000 may seem impressive but is distorted by two factors -- the sharp growth in SBI's profits, which doubled to Rs 2,058 crore in the period; and the very strong boost to profits from the sale of investments (a non-recurring item) for many banks. Without these the 1999-2000 performance might have been worse.

Besides, net interest margins (spread) for these banks have been squeezed to around 2.70 per cent in 1999-2000 and are likely to slip further with increased competition. Consider the millstone of NPAs of Rs 53,294 crore as of end March 2000 and which show every sign of becoming heavier because of the economic slowdown.

Factor this in and it becomes clear why bank stocks underperformed the market indices for most of this year. The BL-250 and the BSE Sensitive indices registered negative returns of 13 per cent and 15 per cent respectively over the last year, the public sector banks sub-index of the BL-250 was down 29 per cent.

Against this backdrop, two more stocks will shortly join the fray -- Indian Overseas Bank (which came out with its public offer two months ago) and Vijaya Bank which is due to come out with its IPO next week. A number of other potential stock market debutantes, including the Punjab National Bank, Punjab and Sind Bank, Allahabad Bank, Andhra Bank, Canara Bank and State Bank of Hyderabad, have decided to temporarily defer their IPOs.

Capital adequacy demands

Banks are now required to have a minimum capital adequacy of 9 per cent. Except for Indian Bank, all other public sector banks have reached this threshold. But given the high levels of NPAs and the vulnerability of banks to further deterioration because of the slowdown, the current capitalisation level of PSBs is still considered inadequate.

A recent Crisil report pointed out that the capital adequacy levels of Indian banks were undermined by the low provisioning for problem loans. If the banks were to make 100 per cent provisions for problem loans, the net worth would be only 29 per cent of the current levels, it said.

The 9 per cent CAR regime is, therefore, only a starting point, and raising the bar further to 10 per cent and beyond is certainly on the cards. It must also be remembered that the ratio is computed on the year-end figures. If one takes into account sanctions made (because that is technically a commitment by the banks), the CAR of these banks at any point of time before the year-end may actually be over the brink.

Some banks, such as SBI and Bank of Baroda, have decided to maintain a CAR of 12 per cent as part of internal control and risk management, and have also expressed their inclination to raise equity next year.

The other PSBs too would need fresh equity infusions to maintain their growth rates, fund modernisation plans and comply with the increasing capital adequacy regime. But support through recapitalisation by the Government is unlikely.

The Government has already contributed Rs 20,446 crore for recapitalisation and allowed a Rs 6,334.44-crore write-off of losses against the capital of many PSBs. The Government is unwilling to pump in more money, except perhaps to weak banks such as Indian Bank, UCO Bank and United Bank of India -- with stringent conditions attached.

As part of the reforms process, banks are now expected to approach the market to broaden their capital base, however unpalatable the option. In its latest Budget, the Government announced its intention to bring down its stake to 33 per cent in all nationalised banks (though it is not prepared to concede any reduction in SBI) to kickstart the divestment process.

Some banks have put on hold their IPOs, apparently waiting for an opportune moment to realise a `premium price'. It needs pointing out that even `concessionary pricing' through a par offer may not improve their stock market fortunes. Consider Syndicate Bank which came out with an offer at Rs 10 in October 1999 and is currently traded at Rs 9.

Why the investor apathy?

Investors do not find the banking sector attractive. A lot of this has to do with the sluggishness of banking sector reforms in the last three years. Among the steps necessary for the second phase of banking reforms are:

*Reduction in the government stake and control in public sector banks;

*Greater autonomy for banks in operational matters;

*Enable full computerisation and networking of branches;

*Install a new legal framework that will punish defaulters and encourage the settlement of problem loans;

*Flexibility in pay matters -- delinking from government scales and jettisoning the uniform industry-wide wage settlements;

*Better training and upgrading skills for credit appraisal and risk management;

*Compliance with tighter prudential norms and improved disclosure practices;

*VRS schemes to reduce excess staff where necessary;

*Closure of unviable branches; and

*Consolidation in the banking sector through mergers and acquisitions.

All these measures, though much talked about, have seen little progress in implementation. Investors, and especially foreign institutional investors, have become restive over the lack of movement and shifted their interest to other sectors.

The missed opportunity

Much was expected of Budget 2000 with regard to banking sector reforms. It turned out to be a damp squib. The Government's stubborn insistence on retaining the ``public sector character'' of these banks even after reducing its stake to 33 per cent was not welcome. That was enough to dampen any hopes of a change in the Government's attitude on such issues as autonomy and privatisation. It was obvious that the Government would continue to call the shots even if its shareholding fell to 1 per cent. There really was no sanctity to the 33 per cent holding except that it reiterated the Narsimham Committee recommendations. Therefore, the reduction in the Government stake to 33 per cent, even if it happens in the next year or two in many public sector banks, is unlikely to induce buying of bank stock.

Economic slowdown may hurt

The revival in the economy in 1999-2000 seems to have petered out. The Index of Industrial Production grew 5.4 per cent in the first half of this fiscal compared to 12.3 per cent in the second half of the previous year. The spectre of the oil-price-hike-led inflation now looms large over the economy. Perhaps, the only silver-lining is the continued growth of exports which clocked 22 per cent in the first half. However, the threat of a slowdown in the US economy because of oil prices and monetary tightening in the Euro zone could spell difficulties for Indian exporters soon.

The immediate implication of a slowdown in the economy will probably be both a decline in credit offtake this year and the possibility of rising loan defaults in the next 6-12 months. Asset quality concerns, which were receding at the end of the previous fiscal on expectations of robust economic growth, are likely to rear up again. Besides, trade liberalisation, as a consequence of WTO agreements in the coming fiscal, are likely to hurt Indian industry, and by, extension banks.

Even the recent history of India Inc bears that out. The bad loan portfolio of banks and institutions contain a number of erstwhile big names in textiles, cement and steel industries. These companies were done in even when there was a `calibrated' reduction in import duties. With the removal of the protection offered by high Customs duties and quantitative restrictions, the imminent shake-out in industry can only have further negative consequences for banks asset quality.

Are banks preparing for this? Not really. Limited awareness of the problem has resulted in a feeble attempt at getting small- and medium-clients to upgrade technology and capacity. A systematic winding down of loan exposures in identified problem areas is ruled out by senior bank officials. ``We will find it very difficult to turn down a request for enhancement of credit when the unit is running well today, but is likely to face problems next year!'' Precisely. History repeats itself.

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Investment outlook

The five top listed banks in the sector -- SBI, Bank of Baroda, Bank of India, Oriental Bank, and Corporation Bank posted a 35 per cent growth in profits for the first half of this fiscal. It is doubtful if this growth can be maintained in the second half. Though the second half is traditionally the busy season and has seen significant incremental credit growth in the past, it may not happen this year. Major projects are still to take off and disbursements to the infrastructure sector trail sanctions considerably. A rise in the NPAs, because of economic slowdown, is a distinct possibility, despite the attempts at recovery through settlement schemes. There will also be the cost of VRS and IT plans to contend with.

The interest rate outlook is uncertain. Expert opinion remains divided on its direction. The reduction in the government stake to 33 per cent is unlikely to trigger re-rating of public sector bank stocks. In fact, the impending equity dilution and the expected lower growth in earnings only point to the continued underperformance of public sector banks on the bourses. Investors can use any uptrend from current levels to exit these stocks.