The focus of the restructuring is to reduce the cost of funds and expand IDBI's net interest margins (spread of interest income over interest expense expressed as a proportion of funds deployed).

Thus, accepting retail deposits is a crucial ingredient in the scheme of things. The incremental cost of funds for IDBI was about 8.4 per cent at end-March 2003.

With savings deposit rate ruling at 3.5 per cent, acceptance of retail deposits will bring down the incremental cost of funds to between 4 per cent and 5 per cent. That is the rate at which most public sector banks are raising funds now.

The restructuring of IDBI's high-cost debt will also reduce the interest burden. Interest rate on debt of about Rs 17,000 crore, constituting around one-third of the total borrowings, is to be reduced to 8 per cent.

Repayments of high-cost rupee borrowings, which were about Rs 21,000 crore in 2002-03, are also expected to continue.

Savings in interest cost due to repayments was Rs 462 crore in 2002-03 and is expected to be about Rs 650 crore in 2003-04.

In addition, the moratorium on CRR and SLR will provide IDBI with an advantage vis-à-vis other banks. CRR and SLR requirements impose costs on banks.

With CRR deposits with the RBI earning at the bank rate of 6 per cent and SLR investments earning between 4 and 5.6 per cent, the spreads are either thin or non-existent.

However, IDBI will not have to shoulder any such burden for another five years. Consequently, the incremental spread of IDBI should rise sharply from the present levels of 1.3 per cent to a level above 3 per cent. In addition, being a new entrant into certain segments of banking, its high-cost structure could have become a liability. Now, with incremental cost of funds set to decline sharply, it can deal with competition effectively.

Burden of the past

However, while the prospect of an upsurge in the net interest margins of IDBI is encouraging, that alone may not be sufficient to convert IDBI into a bank earning super profits. IDBI's return on net worth is less than 6 per cent, mainly because of the incidence of non-performing assets. In fact, reduction, rather than containment alone, in non-performing assets, appears necessary to boost profit growth.

Reduction in the pile of bad loans is essential, because IDBI's net non-performing assets to net advances ratio of 14.2 per cent is the highest in the banking industry.

At Rs 7,330 crore, net NPAs are higher than IDBI's net worth of Rs 6,978 crore at end-March 2003. IDBI also has Rs 4,354 crore of restructured standard assets in its portfolio.

In short, unless there is a qualitative improvement in its asset portfolio, provisions will only keep rising. In this context, the developments in 2002-03 are not promising at all. About Rs 1,500 crore was added to the pile of gross non-performing assets.

This was also reflected in the 44 per cent rise in the provision for non-performing assets of Rs 1,110 crore. Provisions can only be expected to rise in future.

This is because doubtful advances constitute about 8.6 per cent of the net advances. Doubtful advances are difficult to turnaround and are highly likely to require further provisioning.

Cautious outlook

If provisions rise, a substantial proportion of the benefits derived from improvement in spreads will be eroded.

As such, it is imperative that IDBI's balance-sheet grows at a faster pace. Balance-sheet growth of more than 10 per cent, when spreads are improving, will give it the necessary resources to counter the problem of bad assets.

Profit growth, too, will be adequate to power share price appreciation. In fact, IDBI hopes to achieve these feats. IDBI expects profits to rise at a compounded annual rate of nearly 11 per cent over the next five years. However, retail investors cannot be as sanguine. Balance-sheet growth of more than 10 per cent is not guaranteed. Growing the balance sheet at about 10 per cent by focussing only on top-rated companies, which is the likely strategy, may prove tough.

Even the improvement in spreads is contingent on successful conversion of its offices into branches attracting large deposit inflows. Investors also need to consider the performance of IDBI Bank while evaluating the prospects for IDBI.

The merger of IDBI Bank with IDBI, put to rest for the time being, might raise its head in future. However, the impact of IDBI's conversion into a Bank on IDBI Bank's performance is unknown. If it pulls down the growth rate of IDBI Bank then even the consequent merger may not prove beneficial. In this context, maintaining a cautious outlook appears prudent.

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