Will higher provisions continue to threaten banking profitability?

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Non-performing assets (NPAs) or loans that are not being paid back by the borrowers have consistently been a cause of concern for the Indian banking industry over the last few years. Soaring NPAs are not only curtailing banks’ growth and lending operations, but also causing slowdown in the economy. Sensing the problem, the Reserve Bank of India (RBI) has increased surveillance in 2014 to detect concealed bad loans. As a part of surveillance, the central bank asked banks to report all loan accounts where interest is not being paid in time. After analyzing data for three to four quarters, the central bank realized how bad the asset quality problem is. The RBI then asked banks to recognize large loan accounts where interest is delayed routinely as NPAs.

New Provisions and Profits

After RBI’s rap, the banks have started aggressive balance sheet clean up drive. The results were clearly visible in the third and fourth quarters of fiscal 2016. From September 2015 level, gross NPAs of 30 banks both public and private surged 70.3 percent to Rs 3,399 billion on Mar. 31, 2016. A sharp increase in NPAs forced the banks to set aside higher provisions for bad loans. As a result, provisions jumped to a new high impacting banks’ bottom-line severely for both December 2015 and March 2016 quarters. Public sector banks were worst hit by the amount of provisions that they have kept aside to cover mounting NPAs.

In fact, aggregate provisions for 19 PSU banks more than doubled from Rs 107.8 billion for September 2015 quarter to Rs 248.8 billion for December 2015. From December level, provisions surged more than 50 percent to Rs 380 billion for March 2016 quarter. On year-on-year basis, provisions jumped 144.6 percent for March 2016 quarter. At the same time, private banks have also witnessed a sharp increase in the provisions. Aggregate provisions for 11 private banks have doubled from Rs 29.81 billion for March 2015 quarter to Rs 63.29 billion for March 2016 quarter.

Provisions, when compared with total income, are looking more worrisome. Aggregate quarterly provisions as percentage of total revenue of 19 public sector lenders soared to 38 percent for March 2016 quarter from 15 percent for the same period last year. Similarly, for 11 private lenders, aggregate quarterly provisions as percentage of total revenue jumped to 9 percent for March 2016 quarter from 5 percent for the prior year period.

Punjab National Bank (PNB) and Bank of Baroda hit the headlines recently after reporting record quarterly losses in the Indian banking history. A surge in provisions had impacted bottom-line of both PSUs, which accounted for 45.7 percent of aggregate provisions of 19 public sector lenders for March 2016 quarter. 

Banks’ profitability under attack

Bottom-line of 19 public sector banks remained negative on aggregate basis for second consecutive quarter due to sharp increase in provisions during March 2016 quarter. Aggregate loss of 19 public sector lenders more than doubled to Rs 145.4 billion in March 2016 quarter from a loss of Rs 70 billion in December 2015 quarter. At the same time, private banks also witnessed pressure on profitability on the back of higher provisioning. As a result, aggregate net income for 11 private lenders stood at Rs 86.2 billion for March 2016 quarter, down 21.9 percent on quarter-on-quarter basis or 12.8 percent on year-on-year basis.

Between June 2011 and September 2012, aggregate quarterly provisions for 19 public sector banks were close to their net income. Since then, aggregate quarterly provisions remained higher than the amount of profits that they have earned. Similarly, aggregate quarterly provisions of 11 private banks have also remained in the range during January 2011 to March 2012 period. Later, aggregate quarterly provisions of private banks remained in uptrend from March 2012.

New Provision n Profit graph

Banking stocks beaten down as financial health deteriorates

Health Score, a composite financial measure developed by Heckyl, showed deterioration in financials of most of the banks. Aggregate health score for 24 PSU banks stood at 30.6 (on scale of 0 to 100) on May 16, 2016, down from 35.7 on Sep. 29, 2015. As a result, market capitalization of 24 public sector banks wiped out by 22 percent from Rs 3,696 billion on Sep. 29, 2015 to 2,881 billion on May 16, 2016. Out of 24 PSU banks, 15 lenders witnessed a decline in health score, while 6 banks recorded an increase and for 3 lenders it remained stable.

On the other hand, aggregate health score of 16 private sector banks remained stable during the same period. Aggregate market capitalization of 16 banks increased by 2.8 percent from Rs 7,892 billion on Sep. 29, 2015 to Rs 8,114 billion on May 16, 2016. Out of 15 private banks, 7 lenders witnessed a decline in health score, while 6 banks recorded an increase and for 2 lenders it remained stable.

New Health Score

Have banks adequately covered their NPA?

During the third and fourth quarters, 17 PSU banks have set aside Rs 613.8 billion as provision for bad loans, which was more than provisions that they have recorded in the preceding 5-quarters (Rs 546.4 billion). Despite allocating huge amount of funds, the provision coverage ratio (PCR), a measure of the funds set aside by banks to cover NPAs, slipped for most of the public sector lenders. Out of the 17 public sector banks, 14 lenders have recorded a drop in PCR. Meanwhile, 4 out of 7 private banks witnessed a decline in PCR.

Total provisions for these 17 PSU banks stood at Rs 1,487 billion up to Mar. 31, 2016, up 81 percent from Rs 821 billion up to Mar. 31, 2015. At the same time, gross NPAs 17 public sector lenders have almost doubled from Rs 1,401 billion on Mar. 31, 2015 to Rs 2,774 billion on Mar. 31, 2016. As the surge in gross NPAs for 17 PSU lenders outpaced the growth in total provisions, weighted average PCR has declined sharply by 504 basis points.
Weighted average PCR for 17 PSU banks fell to 53.6 percent on Mar. 31, 2016 from 58.64 percent on Mar. 31, 2015. On the other hand, weighted average PCR for 7 private banks decreased marginally from 63.97 percent on Mar. 31, 2015 to 63.52 percent on Mar. 31, 2016.

A decline in PCR is not a good sign as it reduces the cover for bad loans. Higher PCR is the need of the hour for PSU banks as bad loans are growing at rapid pace.

New PCR

Bottom-line:

To catch up with soaring NPAs, public sector banks will have to set aside higher amount of provisions over the next few quarters, which will likely to keep their profitability under stress. On the other hand, private lenders are better placed when compared with their counterparts. But that doesn’t mean, they are out of the woods. In the recently concluded quarter, profitability of private sector banks also got impacted due to higher provisioning. Any uptick in provisions can bring down their profits from current level.

Future trajectory of provisioning requirement depends on how effectively the banks, particularly public sector, controls the ongoing NPA crisis. If deterioration in the NPA level continues, then asset quality crisis in the Indian banking system will accentuate further.

Stay tuned to Heckyl Blogs, we will be highlighting “NPA crisis and how banks can tackle it” in our next blog.

To know more, mail us at info@heckyl.com

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