The finance Ministry is making it mandatory for Public sector banks to meet their loan recovery targets and only then would they qualify for fresh capital investment.
This move is a step in the right direction and it could improve the profitability of the banks and reduce bad loans in future. The government has mandated that state run banks to recover at 20% of their written down loans and the thrust of the government as of now is recovering rather then lending.
Bad loans are a source of worry for the banking sector with accounts such as kingfisher Airlines and Deccan Chronicle defaulting. Besides there are concerns that more than Rs 3.25 crore in loans may be restructured of which a fourth may turn bad if economic conditions do not improve.
The performance of PSU banks compared to their private sector peers has highlighted the need to work towards recovery. The decision to link capital infusion to recovery is aimed to incentivise banks to beef up recovery capabilities. It is estimated that the total write off of PSU Banks was at Rs 2300 crore in 2011 -12. At the same time PSU banks recovered Rs 47,000 crore while the gross NPAs was at 1.17 lakh crore.
To meet regulatory capital PSU banks require Rs 17,000 crore in this fiscal year. – Loans recovered during the year as a percentage of gross NPAs outstanding – improved to 59.8% in 2011-12 from 56.8% a year earlier. So therefore the Finance Ministry is keen that PSU Banks work towards recovery of loans.
The finance ministry is also keen that PSU banks lower their deposit rates and to pass on the benefit to borrowers by lowering lending rates. Another mandate from the ministry is that PSU banks must control costs – a pre condition to reducing lending rates.
At the same time banks appear strapped for cash as deposits have remained sluggish much lower than the credit off take for almost two years. According to bankers the reason is higher inflation along with higher returns from alternate investment avenues has made fixed deposits unattractive.. As a result banks have started offering higher rates on both retail and corporate deposits
The Ministry has also instructed that PSU banks reduce bulk deposits to 15% of the total deposits by the end of the current financial year. The share of CASA (current and savings account) deposits in total deposits declined during 2011-12, due to the decline in demand deposits as well as slow down in saving bank deposit mobilization.
While bankers have indicated that asset quality pressures are much higher in sectors such as steel, infrastructure, construction and textiles the Ministry has highlighted the need for credit flow to the stressed sectors. The Ministry also felt that credit flow to the housing and automotive sector was important for the overall economic growth. In the past two years most banks have reduced lending rates for the auto and home loans to boost their retail portfolio.
Also PSU banks have lowered their provision coverage ratio in the last one year which if implemented at 70% would have had the effect of lowering the quarterly profits
Provision coverage ratio is the ratio of provision to gross non performing assets (NPAs).
Though the RBI has withdrawn the requirement for 70% loan loss cover from September 2011,, Private sector banks whose asset quality is better than their public sector counterparts have maintained provision cover of more than 70%.
For the quarter ended September most public sector banks reported provision coverage ratios of less than 70%. According to RBI data, the provision coverage ratios for PSU banks stood at 47.6% as of March end compared with 49% a year earlier. With the economic downturn witnessed over the last two years, the impact has been severe in the case of PSU banks which have seen deterioration in asset quality. The banks are also in need of fresh infusion of funds. The government has earmarked a sum of Rs 15,000 crore and the banks that require capital the most are Indian Overseas Bank, Central Bank of India and Bank of Maharashtra.
With the mandate from the government to banks to focus on recovery as well control costs the profitability of PSU banks are likely to shows an improvement. The stressed asset quality and a host of other negatives appear to have been factored in the stock prices of most PSU banks.
With a reduction in interest rates likely in the month of January and a slew of reforms promised by the finance minister going forward the economy is likely to reverse from the present slowdown which in turn will result in recoveries for most of the public sector banks and which in turn will improve their financial performance. PSU banks like State Bank of India, Punjab National Bank, Bank of Baroda, Bank of India, Canara Bank appear excellent investment bets for investors having a one to two year time horizon.