Fasten your seatbelts: Not only United Bank, a major part of banking is in trouble

 indian rupeesVivek Kaul 

In an editorial today (i.e. February 26, 2014), on the troubled United Bank of India, The Financial Express asks “Wasn’t anybody watching?”. “It is amazing that things could have been allowed to come to such a pass without action being taken to stop it,” the pink-paper points out.
In fact, The Financial Express should have been asking this question about the Indian banking sector as a whole, and not just the United Bank in particular. As of September 30, 2013, the stressed asset ratio of the Indian banking system as a whole stood at 10.2% of its total assets.
This is the highest since the financial year 2003-2004 (i.e. the period between April 1, 2003 and March 31, 2004) point out
Tushar Poddar and Vishal Vaibhaw of Goldman Sachs in a recent report titled India: No ‘banking’ on growth.
Interestingly, the public sector banks are in a worse situation that their private sector counterparts. As the latest
RBI Financial Stability Report points out “Among the bank-groups, the public sector banks continue to have distinctly higher stressed advances at 12.3 per cent of total advances, of which restructured standard advances were around 7.4 per cent.”
The stressed asset ratio is the sum of gross non performing assets plus restructured loans divided by the total assets held by the Indian banking system. What this means in simple English is that for every Rs 100 given by Indian banks as a loan(a loan is an asset for a bank) nearly Rs 10.2 is in shaky territory. The borrower has either stopped to repay this loan or the loan has been restructured, where the borrower has been allowed easier terms to repay the loan (which also entails some loss for the bank) by increasing the tenure of the loan or lowering the interest rate.
The restructuring of a loan happens through the Corporate Debt Restructuring(CDR) cell. The Goldman Sachs analysts point out in their report that
85% of restructured loans were restructured during the last two years (i.e. financial year 2011-2012 and 2012-2013).
What makes the situation even more precarious is the fact that the stressed loans could keep increasing. Goldman Sachs projects that among the banks its research team covers stressed loans could go up by as much as 25% in 2013-2014 (i.e. the period between April 1, 2013 and March 31, 2014). Also, some of the troubled loans have still not been restructured or classified as bad loans by banks. Hence, the situation is worse than what the numbers tell us.
As Akash Prakash of Amansa Capital wrote
in a recent column in the Business Standard “Most investors believe that many of the problem assets are yet to be recognised by the system. These banks continue to increase their exposure to the problem areas of power and infrastructure.”
Five sectors, namely, Infrastructure, Iron & Steel, Textiles, Aviation and Mining, have the highest level of stressed advances. “At system level, these five sectors together contribute around 24 percent of total advances of SCBs [scheduled commercial banks], and account for around 51 per 
cent of their total stressed advances…The share of above mentioned five sectors in the loans portfolio of Public Sector Banks,” the RBI Financial Stability Report points out. Hence, the public sector banks are in greater trouble than their private counterparts.
Of the five sectors the infrastructure sector has contributed around 30% of the total stressed assets even though its share of total loans is only about 15%.
The banks have also not been provisioning enough money against stressed loans. “Moreover, provisions for stressed assets are still low, and the lowest in the region. For public-sector banks under its coverage, our Financials Research team assesses the provision coverage ratio for stressed loans at only 24%,” write Poddar and Vaibhav.
What this means is that the banks are not setting aside enough money to deal with prospect of a greater amount of their stressed loans being defaulted on by borrowers and turning into bad loans. And to that extent, banks have been over-declaring profits. That wouldn’t have been the case if they had not been under-provisioning.
Despite the under-provisioning the capital adequacy ratio of banks has fallen dramatically in the recent past. “The Capital to Risk Weighted Assets Ratio (CRAR) at system level declined to 12.7 per cent as at end September 2013 from 13.8 per cent in as at end March 2013…At bank-group level, PSBs recorded the lowest CRAR at 11.2 per cent,” the RBI Financial Stability Report points out. In fact, since September 30, the capital adequacy ratio of the entire banking system would have fallen even more, given that bad loans have gone up. The capital adequacy ratio of a bank is the total capital of the bank divided by its risk weighted assets.
In the days to come, the banks, particularly public sector banks (given their falling capital adequacy ratio), will have to raise more capital to have a greater buffer against the mounting bad loans. The RBI estimated in late 2012 that banks need to raise around $26-28 billion (or around Rs 1,61,200 crore – Rs 1,73, 600 crore, if one dollar equals Rs 62) by 2018.
This is a huge amount. “The capital raising requirement could increase to US$43bn [Rs 2,66,600 crore] under a stress scenario where gross NPLs[non performing loans] and restructured assets rise to 15% of loans, the previous historical high,” estimates Goldman Sachs.
So where is this money going to come from? For the financial year 2014-2015 (i.e. the period between April 1, 2014 and March 31, 2015). the finance minister P Chidambaram has set aside only Rs 11,200 crore for capital infusion into public sector banks. This is simply not enough.
So should government pump in more money into the banks? It simply doesn’t have the capacity to do so. As Akash Prakash writes “There is no way the government can fund this; there is simply no fiscal capacity. Nor do investors want to stand in front of this freight train, since the capital needs for most banks are greater than their current market capitalisation.”
Let’s take the case of the United Bank of India. The current market capitalisation of the bank is around Rs 1442 crore(assuming a share price of Rs 26). The government has decided to pump in Rs 800 crore into the bank. Given that, the market capitalisation of the bank is around Rs 1442 crore, which private investor would have been ready to pump in Rs 800 crore? Also, when the State Bank of India tried to sell shares worth Rs 9,600 crore to institutional investors recently, it failed to raise the targeted amount and had to be rescued with the Life Insurance Corporation pitching in and picking up its shares.
If the biggest public sector bank in the country, which accounts for nearly 20% of Indian banking, is unable to sell its shares completely, what is the chance for other public sector banks being able to do so?
Given these reasons, Indian banking is in for a tough time ahead. Fasten your seatbelts. 

The article originally appeared on www.FirstBiz.com on February 26, 2014. 

(Vivek Kaul is a writer. He tweets @kaul_vivek) 

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About vivekkaul
Vivek Kaul is a writer who has worked at senior positions with the Daily News and Analysis(DNA) and The Economic Times, in the past. He is the author of the Easy Money trilogy. Easy Money: The Greatest Ponzi Scheme Ever and How It Is Set to Destroy the Global Financial System , the latest book in the trilogy has just been published. The first two books in the trilogy were published in November 2013 and July 2014 respectively. Both the books were bestsellers on Amazon.com and Amazon.in. Currently he works as an economic commentator and writes regular columns for www.firstpost.com. He is also the India editor of The Daily Reckoning newsletter published by www.equitymaster.com. His writing has appeared across various other publications in India. These include The Times of India, Business Standard,Business Today, Business World, The Hindu, The Hindu Business Line, Indian Management, The Asian Age, Deccan Chronicle, Forbes India, Mutual Fund Insight, The Free Press Journal, Quartz.com, DailyO.in, Business World, Huffington Post and Wealth Insight. In the past he has also been a regular columnist for www.rediff.com. He has lectured at IIM Bangalore, IIM Indore, TA PAI Institute of Management and the Alliance University (Bangalore). He has also taught a course titled Indian Economy to the PGPMX batch of IIM Indore. His areas of interest are the intersection between politics and economics, the international financial crisis, personal finance, marketing and branding, and anything to do with cinema and music. He can be reached at vivek.kaul@gmail.com

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