Between 26 October, a day after the government announced a Rs2.11 trillion capital infusion into public sector banks (PSBs), and 8 March, shareholders of these banks have lost Rs1.56 trillion in combined market value. The market capitalization of the banks has dropped to Rs3.95 trillion from Rs5.51 trillion in this period. The government, which holds between 86.81% and 55.52% in these banks, is the biggest loser—the value of the stocks it owns is now lower by Rs97,386 crore, having dropped from Rs3.42 trillion to Rs2.45 trillion.
There are quite a few reasons behind the value erosion, including growing incidents of fraud, ballooning bad assets and a sharp drop in profitability. In the three months ended 31 December, the pack of 21 PSBs posted a net loss of Rs18,097 crore, a more than fourfold increase (Rs4,284 crore) from the year earlier quarter. A bigger worry is that they will continue to post losses for many more quarters, and the quantum of loss will probably rise in March.
Sixteen PSBs posted net losses in the December quarter, led by State Bank of India (Rs2,416 crore) and Bank of India (Rs2,342 crore). Five PSBs that reported profits are Indian Bank, Canara Bank, Bank of Baroda, Vijaya Bank and Punjab National Bank, which is now neck-deep in a $2 billion letter of undertaking fraud. In the September quarter, 11 PSBs had posted losses.
Why did these banks post such massive losses? They had to provide for their rising bad loans as well as erosion in the value of their bond portfolio because of the rise in yields (bond prices and yields move in opposite directions) even as there was no significant rise in their interest income (this is because most of them are reluctant to give new loans) and fee income. Banks do not earn any interest on their bad loans and, on top of that, they need to set aside money or provide for such loans.
IDBI Bank Ltd tops the list of banks with the biggest lump of bad loans—almost one-fourth of its loan book has turned sour. Three other banks have more than one-fifth of their loan books turning bad—Indian Overseas Bank (21.95%), Uco Bank (20.64%) and United Bank of India (20.1%). At least six more banks have more than 15% but less than 20% gross bad loans and eight between 10% and 15%. This means, only three PSBs have less than 10% gross bad loans, Vijaya Bank having the least—6.17%.
After making provisions, IDBI Bank has 16.02% of its loans as net non-performing assets, or NPAs. While IDBI Bank is the only instance of a government-owned bank having above 15% net NPAs, there are seven of them with more than 10% and up to 13.08% net NPAs. Indian Bank has the lowest net NPAs—3.3%.
The worst is certainly not behind India’s public sector banks. In percentage term, only eight of the 21 banks have been able to bring down their gross bad loans in the December quarter; a combination of hefty provisions and a marginal slowdown in fresh slippages have led to 11 PSBs bringing down their net NPAs. Overall, their gross bad loans have risen to Rs7.77 trillion in the December quarter from Rs7.3 trillion in the September quarter and, after provision, net NPAs have risen from Rs3.7 trillion to Rs4.16 trillion during this period. Including the private banks (and excluding foreign banks), the industry’s gross bad loans in December were to the tune of Rs8.86 trillion.
Till September 2015, the rise in Indian banks’ bad loans every quarter was rather muted; it gained momentum from December 2015 when the Reserve Bank of India (RBI) conducted the so-called asset quality review, or AQR, whereby the central bank’s inspectors swooped down on banks, checked their books and forced them to come up clean in six quarters by March 2017.
Let’s take a close look at how India’s public sector banks’ profitability has been hit following this. In the September 2015 quarter, only two PSBs had made losses (Bank of India and Indian Overseas Bank). Data compiled by Mint Research Bureau’s Ashwin Ramarathinam shows that in the subsequent nine quarters—between December 2015 and December 2017—IDBI Bank has made an accumulated loss of Rs11,949 crore, recording losses in seven of the nine quarters. Bank of India comes second with an accumulated loss of Rs10,347 crore; Indian Overseas Bank’s accumulated loss is less (Rs9,022 crore), but it has the distinction of making losses for 10 straight quarters, including September 2015.
Uco Bank, too, has made losses in nine consecutive quarters, but it can draw consolation from the fact that its accumulated loss (Rs7,365 crore) is lower than that of Indian Overseas Bank. It shares the honour with Central Bank of India, which, too, has made losses for nine quarters at a stretch, but the sum is marginally less, Rs7,165 crore. Two other banks that have made losses for eight quarters out of nine are Dena Bank and Bank of Maharashtra, while Oriental Bank of Commerce has made losses in six quarters. Only two banks have passed this tumultuous time unscathed—Indian Bank and Vijaya Bank; they have not posted loss even in one of the past nine quarters since December 2015.
Indeed, the increase in bond yields has hit most banks hard in the current financial year, but the villain of the piece is the rising bad loans. Unfortunately, banks will continue to suffer as the latest RBI norm will goad lenders to clean up their bad loans with more vigour. From March, they need to classify all large loans worth at least Rs2,000 crore as NPAs the moment they are restructured. If the banks cannot resolve the bad loans within 180 days, they would need to move the Insolvency and Bankruptcy Code (IBC) court, where the resolution process must complete within 270 days. This means the banks will have to continue to provide for their bad loans and take haircuts, most often deep, to resolve them. This will continue to affect their profitability, and the losses may rise in the coming quarters.
Apart from the bad loans for which they would need to set aside money, the rising bond yield will also hit the banks hard. Since January, the yield on the benchmark 10-year paper has risen by at least 42 basis points. One basis point is one-hundredth of a percentage point.
Continuous losses will erode banks’ capital. On top of that, the banks have started recalling the additional tier 1, or the so-called AT-1 bonds, which they have been raising since 2014 to shore up their capital. Rating agency Icra Ltd has estimated that PSBs have raised Rs60,385 crore through AT-1 bonds. Out of this, 11 PSBs which have been under the so-called prompt corrective action of RBI, which restricts their activities, account for Rs21,900 crore. Three of them—Bank of Maharashtra, Oriental Bank of Commerce and IDBI Bank—are in the process of negotiating with their bondholders for exercising an early call option.
I understand this is being done at the instance of the government. It will reduce the banks’ cost of money, but their capital, too, will get eroded. The only way to augment their income is to start lending activities in a big way, with the economy showing signs of growth; but the fraud-weary banks seem to be inhibited to lend.
So, two unpleasant likely scenarios are staring at India’s public sector banking industry, which has 70% share of assets. One, most PSBs will continue to see NPAs rising and losses mounting even in the next fiscal year; and two, the Rs2.11 trillion recapitalization package of the government (of which Rs88,000 crore has already been infused into 20 PSBs, the exception being Indian Bank) will not be enough to meet their regulatory capital requirements.
Tamal Bandyopadhyay, consulting editor at Mint, is adviser to Bandhan Bank. His latest book, From Lehman to Demonetization: A Decade of Disruptions, Reforms and Misadventures has recently been released. His Twitter handle is @tamalbandyo. Comments are welcome at email@example.com