BOMBAY, 20 September 2004 — Over the past few days, the Indian banking sector has been hogging all the front-page news but for some negative reasons. The fall of Global Trust Bank and then South Indian Cooperative Bank, then the merger of IDBI with IDBI Bank, these news grabbed all the headlines. There was a queasy feeling that all was not right with the Indian banking sector. Why were there so many bank failure stories and can you trust your monies in these banks, such questions dogged the minds.
Well, all those seem to be important lessons which the Indian banking sector has learned, or rather, will keep learning from. And over the past few days, the banking stocks have been scaling new heights on the Indian bourses.
As per reports, the banking sector is witnessing strong recovery in credit growth. The credit growth of Rs, 13,258 crore for the fortnight ended Aug. 20, 2004, figured as the highest in the recent past. Credit growth is being boosted by the vibrant trend in industrial activity and investment cycle. Loan growth is now running at 22 percent year on year, as both consumer and corporate demand is upbeat, a foreign brokerage has noted in a recent report.
Banking stocks gained further ground when last Saturday, the Reserve Bank of India said that it will raise banks’ Cash Reserve Ratio by 0.5 percent over two separate hikes to 5 percent in response to liquidity conditions. The first hike of 0.25 percent to 4.75 percent took place on Sept. 18, while the second hike of the same size will become effective on Oct. 2. Starting from Sept. 18, the central bank has also started paying the banks 3.5 percent as interest on CRR balances instead of 6 percent.
The CRR is the portion of bank deposits to be kept with the central bank. The amount that each bank has to park with RBI is determined as a percentage of deposits raised by it. A CRR hike leaves banks with fewer funds to lend, and can cause the lending rates to rise. This is the first hike in CRR in four years.
Although the hike will take out close to Rs. 8,000 crore from the banking system, it will still leave with more than enough cash. The surplus fund with the banks is in the region of Rs. 40,000 crore. Analysts say that this is the right step to suck out excess liquidity, one of the reasons for the surge in inflation.
There has also been a lot of anxiety in the banking sector over the rising inflation rate. It is expected that when inflation goes up, interest rates also go up. Banks, especially Public Sector banks have been sitting on a huge portfolio of government bonds and there is apprehension as bond prices plunge when interest rates start rising.
Till recently, the going was great for the banks as falling interest rates was leading to windfall treasury gains. But now, with yields rising continuously over the past four months, the bond portfolio of banks is most certainly under pressure. Debt market yields going up means prices of government securities will come down and thereby, reduce treasury gains. Another fallout of this will be a direct reduction in loan provisioning as most of the banks were using their treasury incomes to boost provisioning. Now, provisioning will take a backseat.
Despite this, the future seems to look bright for the banking sector. There is a 20 percent growth in bank loans and analysts say the banking business has never been as robust and profitable. Though the rising inflation is a worrying factor, rising momentum in consumer lending, corporate capex cycle and corporate borrowing will fuel growth rate irrespective of rising yields. Banks are flush with funds and it is unlikely that they will face any liquidity crisis even if yields increase. Moreover with most banks changing their focus to retail, they will make a comeback on the basis of strong and improved fundamentals.
Undoubtedly, the performance of banks will get affected in the short to medium term but the long-term outlook is still positive. In the midst of all this, there has been a lot of consolidation also happening in the banking sector.
Lesser and more bigger the banks, the more efficient the banking system will function. This will also mean that there were will fewer or no incidences like Global Trust recurring again.
The latest news doing the grapevine is that Bank of India might be merged with Union Bank of India. Reports suggest that the merger of the two PSU banks could create India’s second largest bank, with a combined asset base of Rs. 1,44,000 crore — bigger than ICICI Bank and Punjab National Bank, and next only to State Bank of India. Bank of Rajasthan has also been in the news. Foreign investors like Citigroup and Goldman Sachs have picked up substantial quantities of the bank shares in the recent past.
J & K Bank is also in the reckoning after the bank announced that it has received Reserve Bank of India’s approval for increasing the investment limit of Foreign Institutional Investors up to 33 percent of the paid-up equity capital of the Bank. An efficient banking system means the economy is growing in the right direction. So for now, one can safely say that the Indian banking sector seems to be on secure ground.
