Can PSBs withstand the storm of slow growth and higher bad debts? Or will they need government support?

The balance sheets of Indian public sector banks (PSBs) have been deteriorating for the past few years and the quantum of bad debt seemed to have got worse in the last few months, even if the rate of deterioration has slowed down. This has worried policy makers and market watchers. However, Espirito Santo Securities (ESS) believes that PSBs might have some breathing room for the next six to eight quarters, based on policy ‘reforms’ undertaken by the government, right from state electricity board (SEB) restructuring to diesel price hike, as well as initiatives from select private companies to restructure their businesses—from Suzlon to Hotel Leela to GMR, and so on. The report said, “(reforms) are a step in the right direction and we expect them to have a positive impact on the banking system in the next six to eight quarters”.
 

One of the key things that market watchers were expecting from the budget was the question of how the government would handle public sector banks (PSBs) as they have been deteriorating over the last few years and their solvency has been a concern, especially because PSBs have to be essentially capitalized by taxpayers’ money. According to ESS, gross slippage ratio (as a percent of advances) in the third quarter of the 2013 fiscal was as high as 2.6% for Tier-1 PSBs and 2.9% for Tier-2 PSBs (it runs into several thousands of crores if translated to actual figure). This is a high figure and a cause for concern.
 

What about recovery of bad debts? The ESS report said, “Our analysis of asset quality in the past eight quarters shows that asset quality has been volatile and one quarter of improved asset quality cannot be termed a recovery, as there has been minimal macro-economic improvement on the ground.”
 

Market watchers and bankers were hoping that the Union Budget 2013 would address some of their concerns. Alas, nothing major was announced though there were some measures to address PSBs’ solvency. One such measure is the Rs14,000 crore which is to be used towards re-capitalization of public sector banks for FY14, which is just marginally higher than the Rs12,500 crore budgeted last year. While it does not dramatically improve the balance sheet, it is something. Despite this, ESS expects slippages to be ‘volatile’, unless economic conditions improve. The report said, “We expect incremental slippages to remain volatile as the economic recovery is protracted.”
 

Another minor measure announced at the Union Budget 2013 was to remove the arbitrage between liquid funds and bank deposits. Most savers, earlier, were putting money in liquid funds to take advantage of taxation on distributed income on non-equity oriented mutual funds, which has now been doubled to 25%. This would mean, banks will expect more funds to come to savings accounts now. This is a positive for banks, including PSBs.
 

However, one of the bigger concerns for PSBs, according to ESS, is the issue of higher provision requirement, which will severely reduce the return on equity (ROE is one of the key measures used by Moneylife for its value pick section in the magazine). ESS said, “RBI has already increased the provisioning requirements on restructured advances. Given that most PSU banks have low provisioning coverage ratios (PCR), any incremental regulatory changes increasing the provisioning requirements are likely to exert more pressure on the RoEs of PSBs”.
 

Below shows the table and ratings of various PSBs according to ESS:
 

To summarise, it will be a wait-and-watch game for PSBs as economy is still moderating and no one knows for sure how global economy will affect domestic economy. There’s also a risk of inflation run-off, which means there could be a risk of RBI hiking interest rates (though most pundits expect inflation to moderate and rates to be cut towards end of the year), which could kill off PSBs’ momentum in recovery. ESS believes State Bank of India and Oriental Bank of Commerce are top buys while Punjab National Bank is a sell.