When will we see happy ending to the bad loan story of Indian banks?

Everybody is keen to know how India’s banks have been doing. Is the worst behind them in terms of rise in bad assets? Are they back on the profitability track?

Their performance in the December quarter is critical for two key reasons. One, they have just come out of the seven-week note-exchange programme in which high-value notes accounting for 86% of the currency in circulation were invalidated in November-December. Except for interacting with the depositors and making sure that the branches and ATMs are stacked with new notes, the bankers did not have much time to do anything else in those two months. And, two, they are just a quarter away from recognizing their bad assets under the so-called asset quality review or AQR launched by the Reserve Bank of India (RBI) in the second half of calendar year 2015.

Barring two—Allahabad Bank and Dhanlaxmi Bank Ltd—all listed banks have announced their December quarter earnings. The collective net profit of 39 listed Indian banks in the quarter has been Rs10,471 crore, almost nine times their net profits in the year-ago period but less than the September quarter. A comparison with the September quarter is not strictly relevant but typically, the December quarter profits are higher than the September quarter as loan growth picks up post harvest and banks’ interest income rises. This has not happened this time; demonetization can be partially blamed for this.

While 16 listed private banks’ net profit growth has been down around 14%, 23 public sector banks have collectively posted Rs493 crore net profit against a Rs10,425 crore loss in December 2015. Eight public sector banks have posted losses (against 10 in December 2015) and one of them has shown a drop in net profit. Among private banks, only Jammu and Kashmir Bank Ltd has been in loss but five of them, including Axis Bank Ltd and ICICI Bank Ltd, have reported lower profits.

The net interest income—or, what the banks earn on their loans net of cost of funds—has risen around 12% for the private banks but marginally dropped for public sector banks. Overall, the rise has been just around 4% from the year-ago period and less than 2% compared with the September quarter. Compared with the year-ago period, such income of two private banks (ICICI Bank is one of them) and 13 public sector banks (including Punjab National Bank) have gone down. If we compare this with the September quarter, then the number swells to four for private banks (including Axis Bank) and 18 public sector banks. This means for most public sector banks, the loan books have shrunk in the December quarter—a rather unusual phenomenon.

To complicate the matter further, the so-called “other income” of the banks which consists of fee income and treasury profits has also been slowing, sequentially. Indeed, it has gone up 43% year on year but over the September quarter, it is down 4%. For ICICI Bank, other income in the year-ago period included its profits from the sale of shares in its life insurance company. Similarly, the State Bank of India made money selling stake in its life insurance outfit in the December quarter.

Treasury profit of banks has been coming down; the movement of the yield on the 10-year government bond is an indication of that. In the December quarter, the 10-year yield dropped 26 basis points (from 6.77% to 6.51%), much less than the drop in the September quarter—around 61 basis points (from 7.42% to 6.81%). One basis point is a hundredth of a percentage point. For bonds, yield and prices move in opposite directions. So, when the yield drops and prices rise, the banks make treasury profits, trading bonds.

When it comes to provision, or setting aside money for their bad assets, the private banks have been more aggressive. Their provisions in the December quarter have been up 71% over the year-ago period but 31% less what they had provided in the September quarter. For public sector banks, provisions have been down 18% over the year-ago period but up 8% over the September quarter. Axis Bank has set aside Rs3,796 crore for bad loans, the highest among private banks, roughly 40% of what all private banks have collectively provided for. Among public sector banks, State Bank, the largest Indian lender, has provided the maximum —Rs8,943 crore, followed by IDBI Bank, Rs3,206 crore.

In absolute terms, the growth in gross non-performing assets of the listed 39 banks at Rs6.82 trillion has been 59% higher over the year-ago period but over the September quarter, the growth is a little over 4%. Incidentally, the growth has been more in private banks than in public sector banks but the good news is, sequentially, the growth in gross NPAs has been slowing. Data compiled by Ravindra Sonavane and Ashwin Ramarathinam of Mint Research Bureau shows that in absolute terms, the gross NPAs of listed banks sequentially had risen 6.44% in the September quarter, 8.87% in the June quarter, and around 32% in both March and December 2015 quarters. (One caveat though: the current set of 39 listed banks which has shown 4% rise in the December quarter does not include Allahabad Bank and Dhanlaxmi Bank and includes RBL Bank Ltd. The June, March and December quarters figures included the first two but did not have the RBL data.) Barring DCB Bank Ltd, all banks’ gross NPAs have risen.

After setting aside money, the net NPAs, in absolute terms, have risen 57% year on year to Rs3.85 trillion. Sequentially, over the September quarter, the rise has been 2.5%. Six private banks and eight public sector banks have been able to bring down their net NPAs in the December quarter over September.

The bad loans as a percentage of a bank’s loan portfolio does not give us much comfort. Among private banks, Jammu and Kashmir Bank tops the list (11.84%), followed by ICICI Bank (7.91%), IDFC Bank (7.03%) and Axis Bank (5.22%). Barring four, all private banks have shown growth in gross NPAs as a percentage of loan assets in the December quarter. Among public sector banks, three banks have shown a decline. Here, Indian Overseas Bank is at the top of the list (22.42%), followed by UCO Bank (17.18%), United Bank of India (15.98%), IDBI Bank (15.16%) and Bank of Maharashtra (15.08%). At least 12 more public sector banks have between 11% and 15% gross NPAs.

Among these 39 listed banks, three (all belong to the public sector) have more than 10% net NPAs and 18 banks’ net NPAs as a percentage of loan assets are more than 5%. Only four of them have been able to improve their net NPA figures over the year-ago period but compared with the September quarter, 13 banks have bettered their net bad loan data.

This is small consolation. Between August and December 2015, RBI had inspected the loan portfolios of all banks and asked them to set aside money for three kinds of loans—NPAs that they had not recognized yet; loans given to projects where the dates of commencement of commercial operations had passed but the projects had failed to take off; and restructured loans. The banks had to provide for the first two types of loans in two phases in the December and March quarters of fiscal year 2016, at least 50% each. For the restructured loans, they were asked to make 15% provision in six quarters, 2.5% each, till March 2017. So, we will have to wait till March when the entire clean-up exercise gets over.

However, even in March, we will not get the fair picture as the RBI has given the banks a 90-day relaxation on the income recognition norms for small loans payable between November and December. This is to alleviate the pain of small borrowers who suffered from cash crunch because of demonetization. Since non-payment of interest for three months makes a loan bad, following this relaxation, a loan which would otherwise have been classified as bad (if it is not serviced) in March now would be classified so in June.

Indeed, the flood of deposits in November-December has dramatically brought down the cost of deposits for banks but no one knows how much of the pile will remain in the banking system. The outflow already started in January. Once all restrictions on the withdrawal limits are lifted, we will get some idea.

Additionally, two other factors will have a bearing on the balance sheets of banks. A tardy loan growth and shrinkage in their loan books, in case of a few banks, will make matters worse. If the loan book does not grow, NPAs as a percentage of bank loans will rise. Also, hefty treasury income which has been helping banks to clean up their balance sheets and make profits will come down drastically. The 10-year bond yield which dropped to 6.14% in intra-day trading on 25 November 2016, its multi-year low, has risen to 6.80% since then. The honeymoon with bond trading is over; the banks will have to focus on their bread and butter business—loans.

Finally, arrests of senior bankers and putting them behind bars before establishing any mala fide will neither help loan growth nor resolutions of bad asses as a fear psychosis has gripped the banking sector. 

It will take awhile before we get to know how many Indian banks are swimming naked.

This column first appeared in www.livemint.com

Tamal Bandyopadhyay, consulting editor at Mint, is adviser to Bandhan Bank. He is also the author of A Bank for the Buck, Sahara: The Untold Story and Bandhan: The Making of a Bank.

His Twitter handle is @tamalbandyo.

To read his earlier columns, log onto bankerstrust.in