A man pulls a hand-drawn cart in front of the Reserve Bank of India building in Mumbai . Reuters.
In the four weeks of January, BSE’s bellwether equity index, the Sensex, rose 11.5%, the most in the first four weeks of any calendar year in at least a decade. Investors are rushing to buy interest rate sensitive stocks. While BSE’s capital goods index rose by about 28.5%, realty and banking indices rose by at least 23% each, outperforming the Sensex.
The market is convinced that the reversal of the interest cycle is imminent. After 13 rate hikes between March 2010 and October 2011, the Reserve Bank of India (RBI) pressed the pause button in December; and, in January, it pared banks’ cash reserve ratio (CRR)—or the portion of deposits that commercial banks need to keep with the central bank—to ease pressure on liquidity. This has not brought down the cost of money as yet, but has signalled RBI’s heightened concerns for growth even though non-food manufacturing inflation continues to be high. RBI will probably go for another CRR cut in March when it announces the semi-quarterly monetary policy review and the rate cut cycle can begin in April after the Union budget.
Indeed, the pace at which policy rates will be pared is bound to be measured and much slower than the pace of rate hikes, but once the cost of money comes down, corporations will be encouraged to borrow more from banks and invest in projects. Individual borrowers, too, who have shelved plans to borrow to buy homes and cars for fear of not being able to pay the equated monthly instalments (EMIs) of such loans, may revive their plans now. This explains why the capital goods, realty and even the auto indices of BSE have been rising faster than the Sensex.
Theoretically, bank stocks will reap the maximum benefit when the interest rate cycle is reversed, as their bad debts can come down (borrowers’ ability to service debt rises when interest cost is low) and they can make money trading bonds. Low bad debts help banks in two ways as they don’t need to set aside money for such debts; besides they start earning interest when a bad debt turns good. As bond prices and yields move in opposite directions, when yields drop and prices rise banks make profit from selling bonds.
Yes Bank Ltd’s stock rose 36.16%, the maximum among the 14 listed banks that constitute BSE’s banking index, Bankex, followed by Axis Bank Ltd (33.34%) and Bank of India (32.50%). Stocks of six other banks, including ICICI Bank Ltd and State Bank of India, gained at least 25% each. HDFC Bank Ltd’sstock gained the least (13.24%) but it had also lost the least(9%) last year when the Sensex had shed 24.6% and Bankex 31.5%.
While the outlook is bright for the banking sector as a whole, not all banks will see good times. Many banks are yet to announce their December quarter results, but a close look at the earnings of those who have announced makes this abundantly clear. While most private banks have been able to maintain handsome growth in net profits and contain their bad assets, quite a few public sector banks have shown sharp drop or single-digit growth in net profits as they needed to set aside money to take care of growing bad assets.
For instance, Union Bank of India’s net profit dropped 66% to Rs 197 crore, from Rs 580 crore in the year-ago quarter. The reason behind the sharp drop in profit is a massive increase in provision requirement—from Rs 400 crore to Rs 973 crore. Similarly, Bangalore-based Canara Bank’s net profit dropped 21% to Rs 875.56 because it had to set aside more money to cover rising bad debts. Its provision for such debts rose 219% to Rs 501.18 crore. A relatively smaller public sector bank, Vijaya Bank (not part of Bankex), too, posted an 18% drop in net profit while Bank of India’s profit rose 9.64%. Both banks had to make hefty provisions for bad debts.
In contrast, most private banks—Axis Bank is an exception— have made lesser provisions as they are able to contain bad assets. Axis Bank’s net non-performing assets (NPAs) as a percentage of loans have risen from 29 basis points (bps) to 39 bps but most other private banks have managed to either keep their net NPA level unchanged or shown minor improvement. One basis point is one-hundredth of a percentage point.
This has not been the case with the public sector banks. Union Bank’s net NPA has risen by 67 bps and that of Canara Bank and Vijaya Bank by 43 bps and 44 bps, respectively. The point to note is that their net NPAs have risen despite hefty rise in provisions. In other words, had they not made such provisions, they would have been able to post higher profits but their net NPAs would have been bloated. It’s good to see that banks do care for quality of assets but unless they are able to bring down their net NPAs—not by making provisions but by better monitoring of loans, recovery of bad loans and preventing good assets from turning bad—the market will punish them.
