Vijay Kumar Gaba

The latest credit and deposit statistics highlight some noteworthy trends in the Indian economy. During the first fortnight of June 2023, the credit offtake continued to grow at a healthy pace of 15.4% (yoy); though it slowed down on sequential basis. The deposit growth accelerated to 12.1% (yoy) narrowing the gap between credit-deposit growth to 337bps, the lowest in over a year. The gap recorded a high of 875bps in November 2022. Rise in deposit rates and withdrawal of Rs2000 denomination currency notes primarily led to the rise in deposits.

Credit deposit ratio at pre pandemic levels

The Credit to Deposit ratio has been generally improving since the later part of FY22 due to faster growth in credit compared to deposits. On a sequential basis in June 2023, it improved by 60 bps from the immediate fortnight (reported June 2, 2023, due to lower deposit growth than credit growth. The CD ratio is now closer to the pre-pandemic level of 75.8% in Feb 2020 and 75.7% in March 2020.

Liquidity tightening again

The liquidity in the banking system had shown significant improvement in the month of May due to deposits of Rs2000 currency notes and higher government expenditure, However, as per the latest statistics, the system liquidity had reduced to Rs0.83trn on 16 June 2023, as compared to Rs2.4trn on 02 June 2023. The weighted average call rate (WACR) was thus higher at 6.1% in the fortnight ended 16 June 2023, as compared to 4.5% in the comparable period in the previous year.

Personal and rural credit driving credit growth

The bank credit growth in recent months has been largely driven by personal loans, credit to NBFCs (largely consumer focused) and rural credit. A large part of incremental credit therefore could be unsecured.

In the month of May2023 about 42% of total outstanding bank credit was deployed in personal loans including credit card outstanding, and rural (non-food) loans. Personal loans (up 19.2%) were the fastest growing category in May 2023 (vs May 2022 as well as May 21). Credit card outstanding grew at over 30% (yoy) in May 2023.

Within personal loans unsecured loans grew 24% in May 2023, the fastest for any category. Food credit has been degrowing for almost two years, and now accounts for less than 0.25% of the total outstanding bank credit.

Housing loans (share of 47.3% within personal loans) grew by 14.6% y-o-y in May 2023 compared to 13.6% a year ago. Despite reporting healthy growth, the share of housing loans reduced to 47.3% in the personal loans segment as of May 19, 2023, vs. 49.2% over a year ago as unsecured loans grew at a faster pace.

Loans against gold jewellery also witnessed a strong growth of 22.1% y-o-y vs. a drop of 2.2% in May 2022 due to a sharp increase in gold prices in May 2023 vs May 2022. As the price of gold rises, it gives borrowers an additional opportunity to get more credit from the banks with the same quantity of gold.

Credit to NBFCs growing as faster pace

Lending to NBFCs grew by 27.6% y-o-y in May 2023. It continued to be driven by healthy growth reported by NBFCs for their loan disbursement and a shift of borrowings to the banking system. The Mutual Fund (MF) debt exposure to NBFCs also rose by 15.7% (yoy). The total bank lending to NBFCs has almost grown 3x in the past five years. The sharp rise in the popularity of equity funds in the past 5yrs has resulted in slower growth in the debt fund AUM of mutual funds; leading to the rise in reliance of NBFCs on bank credit. Besides, the international borrowings of NBFCs have also registered material decline in the post pandemic period.

Robust growth in credit to service sector

Service sector credit grew at a robust 21.4% in May 2023. Lending to NBFCs (27.6%) and Trade (17.5%) were the notable contributors in the service sector credit growth.  

Industrial credit growing at slower pace

The credit outstanding of the industry segment registered a moderation in growth at 6.0% y-oy in May 2023 from 8.8% in the year-ago period. The outstanding credit to industry accounted for ~24% of the total non-food outstanding. The credit to large industries grew just 3.9% (yoy), while MSME credit grew 12.3%.

The credit to infrastructure segment rose by 1.8% vs. 9.8% over a year ago period due to a slower growth witnessed by the power and road, also a drop in telecommunication and port segments. Overall, slow growth in infrastructure impacted the industry growth. The power segment, which accounts for over half of the infrastructure sector credit, witnesses a marginal growth of 0.3% in May 2023 vs. 9.3% in May 2022.

Asset quality improves NPAs fall to historic lows

Net Non-Performing Assets (NNPAs) of SCBs reduced by 34.0% (yoy) to Rs.1.3trne as of March 31, 2023. The NNPA ratio of SCBs reduced to 0.95% from 1.72% in Q4FY22 which is significantly better than the 2.1% level of FY14.

The GNPA ratio of SCBs reduced to 3.96% as of March 31, 2023, from 6.04% a year ago, and 7.58% as of March 31, 2021.

Accordingly, the provision coverage ratio of scheduled commercial banks (SCBs) improved to 76.3% at the end of March 2023.

For 4QFY23, the credit cost of SCBs stood at 0.58% sharply lower as compared to 1.44% seen in 4QFY21.

(Inputs taken from reports of RBI, SBI, and CARE Ratings. All rights duly acknowledged.)

Chart for the day

 The recent order of the Supreme Court regarding classification of NPAs and payment of compound interest for the period of moratorium has reignited a debate on the state of Indian financial sector. The order of Supreme Court has been received by markets as a relief, as it removes a regulatory overhang and paves way for the banks to proceed with recovery of NPAs. Nonetheless, the next few quarters need to be watched closely for any precipitous rise in bad loans; especially if the recovery appears faltering.

Past few years have been quite challenging for Indian financial services sector. A decade of massive infrastructure building exercise (1998-2008) resulted in significant advancement of demand and therefore unviable projects in key sectors like housing, roads, power, civil aviation, metal & mining, SEZs, Ports etc. resulted in a multitude of stalled and unviable projects. Administrative and regulatory irregularities in allotment of natural resources to private parties led to judicial action, compounding the problem of failed projects. Demonetization (2016) and implementation of nationwide uniform Goods and Services Tax (GST, 2018) led to permeation of stress of MSME sector, especially the unorganized sector. The lockdown induced by Covid-19 pandemic (2020) further exacerbated the stress in this sector.

The process of recognition of the stress in sectors like infrastructure, metal & mining, telecom etc. started with changes in rules in 2014 & 2015. However, the real impetus was provided by implementation of Insolvency and Bankruptcy Code in 2017. The process started in right earnest with identification of top 12 (dirty dozen, 2017) non performing accounts by RBI and initiation of resolution process under IBC. Closer scrutiny of large stressed accounts resulted in collateral damage in terms of exposing of frauds and fraudulent lending at some NBFCs (IL&FS & DHLF) and Banks (Yes Bank, PNB, PMC etc.)

In past 4years, the process of NPA recognition and resolution accelerated; though not at the desirable speed. This entire process has resulted in emergence of some key trends in financial markets:

·         Many weak banks have been identified. Some in public sector of these have been merged with relatively stronger banks. Some in private or cooperative sector have gone under rehabilitation (including management change) process.

·         Most banks have resorted to raising fresh capital to strengthen their capital adequacy. The government has also provided fresh capital to stronger banks.

·         Couple of large non banking financial companies (IL&FS and DHFL) have faced action under IBC. This resulted in massive losses to mutual funds who had been a major lenders to these companies. This has resulted in tightening of funding of NBFCs by mutual funds.

·         The restructuring of perpetual bonds (AT-1) of Yes Bank, triggered a rethink on the risk profile of this important source of capital for banks; thus narrowing the window of raising capital for banks.

·         In view of the elevated stress level, most banks have materially tightened the credit assessment standards. This has resulted in sustained slow-down in credit growth, especially to low rated companies and MSMEs.

·         To manage the rise in deposits, due to fiscal & monetary stimulus and lower consumption during stressed times, many banks have resorted to increased emphasis on high margin personal loans. This trend threatens to put incremental stress on bank’s finances if the recovery falters due to relapse of pandemic or otherwise.

As per the latest Financial Stability Report (RBI, January 2021):

·         Macro-stress tests for credit risk show that SCBs’ GNPA ratio may increase from 7.5 per cent in September 2020 to 13.5 per cent by September 2021 under the baseline scenario. If the macroeconomic environment deteriorates, the ratio may escalate to 14.8 per cent under the severe stress scenario.

·         Stress tests also indicate that SCBs have sufficient capital at the aggregate level even in the severe stress scenario but, at the individual bank level, several banks may fall below the regulatory minimum if stress aggravates to the severe scenario.

·         The overall provision coverage ratio (PCR) improved substantially to 72.4 per cent from 66.2 per cent over this period. These improvements were aided significantly by regulatory dispensations extended in response to the COVID-19 pandemic.

·         At the aggregate level, the CRAR of scheduled urban co-operative banks (SUCBs) deteriorated from 9.70 per cent to 9.24 per cent between March 2020 and September 2020. NBFCs’ credit grew at a tepid pace of 4.4 per cent on an annual (Y-o-Y) basis as compared with the growth of 22 per cent a year ago.

·         In the latest systemic risk survey (SRS), respondents rated institutional risks, which comprise asset quality deterioration, additional capital requirements, level of credit growth and cyber risk, among others, as ‘high’.

As per the rating agency ICRA’s estimates, gross NPA worth Rs 1.3 lakh crore and net NPA worth Rs 1 lakh crore were not recognized as of December 31, 2020 due to Supreme Court interim order. These NPA may get recognized in 4QFY21. A recent note ICRA mentioned,

“In ICRA’s outlook for the banking sector for FY2022, we had estimated the Tier I capital requirements for PSBs at Rs. 43,000 crore for FY2022, of which Rs. 23,000 crore is on account of call options falling due on the AT-I bonds of PSBs while the balance is estimated as equity.

“In the Union Budget for FY2022, the Government of India (GoI) has already announced an allocation of Rs. 20,000 crore as equity capital for the recapitalisation of PSBs. If the market for AT-I bonds remains dislocated for a longer period for the reasons discussed earlier, and the PSBs are unable to replace the existing AT-Is with fresh issuances, this would mean that the PSBs could stare at a capital shortfall based on the budgeted capital.

ICRA also expects that the GoI will provide requisite support to the PSBs to meet the regulatory capital requirements, which means that the recapitalisation burden on the GoI could increase, or the PSBs could curtail credit growth amid uncertainty on the capital availability. Apart from Tier I, as mentioned earlier, there could be reduced appetite from mutual funds along with a rise in the cost of issuing Tier II bonds as the limited headroom for incremental investments in Basel III instruments.”

In my view, the theme to play in financial sector may be “consolidation” and “market share gain” by the larger entities (banks and NBFCs) rather than economic recovery and credit growth. Attractively valued smaller entities may be vulnerable to extinction.

 RBI released the 22^nd edition of its biannual Financial Stability Report (FSR) on Monday, January 11, 2021. The report highlights some key trends that could influence the financial markets in months to come. I note the following red flags raised in the report, which in my view could be relevant to my investment strategy:

Uneven and hesitant recovery, with disconnect in real activity and asset price

Economic activity has begun making a hesitant and uneven recovery from the unprecedented steep decline in the wake of the COVID-19 pandemic. Active intervention by central banks and fiscal authorities has been able to stabilize financial markets but there are risks of spillovers, with macrofinancial implications from disconnect between certain segments of financial markets and real sector activity. In a period of continued uncertainty, this has implications for the banking sector as its balance sheet is linked with corporate and household sector vulnerabilities.

COVID-19 pandemic-induced economic disruptions have exposed some fault lines in global economy. Increased public spending (stimulus) and sharply lower revenue receipts have enlarged the fiscal deficits across geographies, aggravating global debt vulnerabilities.

The credit risk of firms and households has accentuated. This could impact corporate earnings in short term. However, the equity prices continue to reflect strong earnings growth expectations. Developments that lead to re-evaluation of corporate earnings prospects will have significant implications for global flows, going forward.

Capital flows and exchange rate volatility

A hesitant recovery in capital flows to emerging markets (EMs) began in June 2020 and picked up strongly following positive news on COVID-19 vaccines. The response of foreign investors to primary issuances from EMs has been ebullient. Anticipating the COVID-19 vaccine induced economic boost, US yields of intermediate tenors (2– and 5-year) have started edging higher. This could have implications for future portfolio flows to EMs.

EM local currency bond portfolio returns in US$ terms have been lower than local currency as well as hedged returns since early 2020 as emerging market currencies have softened against the US$. This has led to sluggishness in EM local currency bond flows even as global bond markets have been pricing in a prolonged economic slowdown and benign inflationary conditions in Europe and US. In this scenario, any significant reassessment of either growth or inflation prospects, particularly for the US, can be potentially destabilising for EM local currency bond flows and exchange rates.

Improvement in bank asset quality might be misleading

By September 2020, the banking stability indicator (BSI) showed improvement in all its five dimensions (viz., asset quality; profitability; liquidity; efficiency; and soundness) that are considered for assessing the changes in underlying financial conditions and risks relative to their position in March 2020. This improvement reflects the regulatory reliefs and standstills in asset classification mentioned earlier and hence may not reflect the true underlying configuration of risks in various dimensions.

Banks risk losing better quality customers

A sharp decline in money market rates specifically since April 2020, has opened up a significant wedge between the marginal cost of fund based lending rate (MCLR) benchmark of banks and money market rates of corresponding tenor. Expensive bank finance may lead to more credit worthy borrowers with access to money markets shifting away from bank based working capital finance. Such disintermediation of better quality borrowers from banking channels could have implications for banking sector interest income and credit risk.

Banking sector prospects to see marginal changes in 2021

In the latest systemic risk survey (SRS) of October/November 2020 about one third of the respondents opined that the prospects of the Indian banking sector are going to ‘deteriorate marginally’ in the next one year as earnings of the banking industry may be negatively impacted due to slow recovery post lockdown, lower net interest margins, elevated asset quality concerns and a possible increase in provisioning requirements. On the other hand, about one fourth of the respondents felt that the prospects are going to improve marginally.

…stress to come with a lag

Domestically, corporate funding has been cushioned by policy measures and the loan moratorium announced in the face of the pandemic, but stresses would be visible with a lag. This has implications for the banking sector as corporate and banking sector vulnerabilities are interlinked.

Macro stress tests indicate a deterioration in SCBs’ asset quality and capital buffers as regulatory forbearances get wound down.

NPA ratio of banks may see sharp rise

The stress tests indicate that the GNPA ratio of all SCBs may increase from 7.5 per cent in September 2020 to 13.5 per cent by September 2021 under the baseline scenario. If the macroeconomic environment worsens into a severe stress scenario, the ratio may escalate to 14.8 per cent. Among the bank groups, PSBs’ GNPA ratio of 9.7 per cent in September 2020 may increase to 16.2 per cent by September 2021 under the baseline scenario; the GNPA ratio of PVBs and FBs may increase from 4.6 per cent and 2.5 per cent to 7.9 per cent and 5.4 per cent, respectively, over the same period.

These GNPA projections are indicative of the possible economic impairment latent in banks’ portfolios, with implications for capital planning. A caveat is in order, though: considering the uncertainty regarding the unfolding economic outlook, and the extent to which regulatory dispensation under restructuring is utilised, the projected ratios are susceptible to change in a nonlinear fashion.

In light of the findings of FSR, the governor of RBI, Shaktikanta Das has cautioned the investors and financial institutions that “The disconnect between certain segments of financial markets and the real economy has been accentuating in recent times, both globally and in India” and “Stretched valuations of financial assets pose risks to financial stability. Banks and financial intermediaries need to be cognisant of these risks and spillovers in an interconnected financial system.

I take note of the above red flags and continue with my “underweight financials” strategy for 2021.