New Private Sector Banks - Potential Trouble Ahead?

RBI recently published a report on trend and progress of banking in India (2006-07). This has information on the entire banking industry (scheduled commercial banks, co-operative banks, regional rural banks) as well as NBFCs.

There are a total of 82 scheduled commercial banks(SCBs) and the RBI categorises them into four broad categories - public sector banks(28), old private sector banks(17), new private sector banks(8) and foreign banks(29). Some of the salient features of the report are (data for scheduled commercial banks only):

• Aggregate advances grew 30.6% as compared to 31.8% in 2005-06 and 33.2% in 2004-05.
• Aggregate deposits grew by 24.6% as compared to 17.8% in 2005-06
• Lending to sensitive sectors (defined by RBI as capital market, real estate, commodity) : Exposure to sensitive sectors was 20.37% of advances as compared  to 18.84% last year. 20.37% is broken down as 18.71% to real estate sector, 1.55% to capital market and 0.11% to commodities.
• Net NPAs as a % of net advances declined to 1.0% from 1.2% in 2006
• Net profits increased by 27% as compared with 17.3% in 2005-06
• CRAR of all SCBs remained at 12.3% as it was the previous year despite a significant increase in risk weighted assets, well above the minimum RBI
• requirement of 9%
• Tier I CRAR ratio declined to 8.3% from 9.3% of 2005-06 (due to slower growth in reserves and surplus) but Tier II CRAR increased to 4.0% from 3.1% of 2005-06. Still, Tier I CRAR is above the minimum of 6% prescribed by RBI

The report looks good in an overall sense but if we just focus on the section of new private sector banks (essentially comprising of Centurion Bank of Punjab, DCB, HDFC Bank, ICICI Bank, IndusInd, Kotak Mahindra Bank, Axis Bank and Yes Bank), there are some serious issues that crop up. Let me just point out a few
facts in this regard with respect to new private sector banks:

• CRAR of new private sector banks, which had improved in 2005-06 to 12.60%, declined to 12.00%, below the industry average of 12.30% in 2006-07
• Lending to real estate is highest among new private sector banks at 32.30% of their advances. This is quite a high figure - imagine that 1/3rd of the bank's lending is to real estate sector
• Net NPAs as a % of advances increased from 0.8% in 2006 to 1.0% in 2007
• Provisions made for NPAs increased by a whopping 39.43% in new private sector banks as compared to a 6.23% decrease for all SCBs
• Spread on assets for new private sector banks was 3.2% against 3.3% for all SCBs - lowest among all bank categories
• Operating profits of new private sector banks jumped by 46.7% as against 21.2% for all SCBs, the highest increase % among all bank categories

What does the above imply? How do we reconcile the fact that the net profits are growing, spreads are not really that great, NPAs have risen and lending to sensitive sector is very high for new private sector banks?

The answer is simple but not comforting - all deals done by private sector banks have a component of upfront fees in addition to the regular interest that is charged on the loan. These upfront fees are usually structured in such a way that they are a significant chunk so that this income can be booked for the quarter in which the deal is done. If the interest rate were higher, the money would come in over the life of the loan and structuring rates with a heavy upfront fee ensures higher incomes booked at the time of deal initiation. And this is a structure that is accepted by a lot of real estate developers and they are willing to pay the higher upfront. The core interest rate charged to real estate developers would also be higher due to the fact that there is a higher risk weight attached to the asset.

So what is the outlook? RBI is heavily coming down on lending to real estate and these banks would be forced to prune their real estate exposure and this would surely impact their bottomline. The real estate prices have marginally softened in the last six months due to lesser demand from individuals but has not seen a significant dip due to the fact that the developers are not willing to cut prices, even though the sales figures have gone down. And RBI is in no mood to cut interest rates and hence sooner than later, these developers would have to cut prices. And that would affect their repayment capability and this could create more NPAs for these new private sector banks in the coming months.

Stock prices of the new private sector banks are hitting all time highs - but it is time to be cautious on these names.

I removed this post, bcoz BGK jee has already posted it. I forgot about it. Sorry again. Thanks for posting BKG jee.

Edited by omshivaya - 02/Dec/2007 at 10:13pm

Regards NPA, as the following indicates, it is interesting that the worst offenders seem to be Kotak and ICICI

Originally posted by basant   Till date increases in interest rates have been adjusted with increasing the loan tenure and reducing the principal repayment and increasing the interest component in the intallments. But from what it stands now people are paying 90% of their installments toiwards interest costs and just 10% towards loan repayment.

Well this is what ICICI has been doing since 2000. They had a PLR on which they offered loans. When rates increased by 300 bps, they increase their PLR by 500 bps. Then the stopped giving loans on the basis of PLR, the created a new jargon called as FRR which is now used as benchmark. The older PLR based customers are stuck becoz the PLR never came down when rates fell. I have a friend who is still paying his ICICI loan @ 14%. Seems like RBI has woken up to this gimmick - though too late.

Somewhere Mr. Ajith mentioned rates in B'lore stabilized or r falling down. This is bound to happen more in IT dominated pockets. Salaries increments this year seem to be  miniscule - which will arrest rising property rates. The biggest IT products MNC in Pune has already reduced 3% of its work force!

Banks which have a significant exposure to retail (and mostly big ticket customers (or fools) are mostly in b'lore/hyd/pune/mumbai - might face some music.

The way these people offer credit cards, is just bewildering: no wonder they need stronger recovery agents.