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Indian banks’ asset quality woes largely sorted out: Nilanjan Karfa, Nomura


Over the last many years, an association that has been inextricably linked with the Indian banking system is that of an entity that is almost sinking under the weight of loans that may perhaps never be recovered. That unfortunate coupling has now largely been eroded, believes Nilanjan Karfa, Executive Director, Banks and Financials – Equity Research, India, Global Markets, Nomura.

“The asset quality issues, therefore, seem to be largely sorted out, as well as the issues that may be encountered from the loans that we had done in the past,” Karfa said in an interview to ETMarkets.com.

According to latest data released by the Reserve Bank of India scheduled commercial banks’ gross non-performing asset ratio fell to 7.3 per cent at the end of March 2021 and then to 6.9 per cent at end September 2021 from 8.2 per cent at the end of March 2020. Edited excerpts:

The Budget has envisioned a degree of a push for digitalisation and most analysts seem to be bullish on the banking sector. With two years of the pandemic behind us, do you feel that we are now on an improved footing with regard to asset quality issues? What is your outlook on banking stocks?
A couple of things work when somebody is bullish on the banking or BFSI sector.

One is the relative underperformance of broadly last year. So if money has to move out of the overvalued or highly valued consumer sector, internet sector and stay within India, it is quite possible that on a relative basis, the banking sector might just do better.

That is more on the technical side. On a fundamental side, two or three things work out.

The banks are probably the best capitalised ever in the last 20 plus years. There should be ample appetite for growth, provided there is the right kind of demand. While the supply side seems to be pretty okay; demand side is a little bit of a question mark.

Second if you look at the problems of last 10 years – towards 2018, 2019 suddenly those flared up all over again because of the NBFC crisis and then subsequently with emergence of Covid – essentially the entire band of ticket sizes from large corporate to mid corporate to even small ticket loans to individual loans came under stress.

There will still be some pockets here and there, but what we have just witnessed in the last 10 years is a complete sweep out of leverage in every possible segment within the economy. While there may be pockets here and there, some restructuring that has happened, some guarantee schemes (some of which will fail), we probably are not going to go back to anything that we have witnessed in the last three years and certainly not in the last six-seven years.

The asset quality issues, therefore, seem to be largely sorted out as well as the issues encountered from loans that we had done in the past. But what probably is going to matter more is what is going to drive the revenue. That is where there is a bit of a debate. It seems to me that a large part of the market is a lot more optimistic than I am. Am I personally super optimistic? The answer is no but I am reasonably optimistic.

So is demand going to be coming back in a hurry? It seems a little unlikely! There has been a broad income loss within the larger segments of the economy.

Imagine it as a steam engine. If you recall how a steam engine works – for all the wheels to start working in tandem, it takes a bit of a time. So there will be wheels which start and then start slipping without the locomotive moving; similarly for the economy, there are various cycles, various ecosystems, interconnections between them. For all of them to start functioning all over again is going to take a bit of time.

How much time is tough to say but we are on that curve right now. Unless something dramatically worrisome comes back on the health front, people will come back to work, commerce; people need money to survive and so it will come back. People will come back and look for income generating opportunities which will in turn translate to more loans and more fees for the banks to start throwing up the revenue. Revenue minus expenses i.e. operating profits. A reasonable amount of upward swing is possible over the next two years.

The combination of larger-than-expected fiscal deficits and government borrowing and hardening oil prices have pushed up sovereign bond yields in the current quarter even as a dovish RBI has softened the blow to an extent. In terms of the mark to market impact on treasury books, how will banks navigate the situation?
There is no navigation; it is a hit that will have to be taken. So to an extent, there are conflicting interests.

If you look at the system, on one side there is a government which will have to borrow, most of it in longer tenure treasuries and the entities which subscribe to them; a large part is banks, so banks will have to subscribe to higher tenure papers.

A higher tenure paper in a rising rate cycle obviously means there will be losses from the existing book. So one might as well live with it but there are counter balances.

For the PSU banks, the rise in yields is more relevant than for the private sector banks and specifically also because the duration of the books for PSU banks is a lot larger. It is higher than private sector banks and so PSU banks tend to get a little bit of a knock on their treasury income when the rates go up. But on the other side, there are factors which benefit them on the opex line.

Net-net there is still a negative but the markets tend to ignore it because if a large part of these books are typically held over their lives, there may be a notional time value loss but there is not an eventual loss. So when markets look at banks they will typically remove this volatility and then look at the core operating profit. So as long as that is holding up, it should not be a concern unless we see a very sharp spike up which is unpredictable.

Coming to the situation on credit offtake; loan to deposit ratio is still near a historic lows. What is your outlook and what could be your estimate for loan growth for the coming financial year as a whole?
It seems as if we are really on the path of recovery and then if you broadly split down the incremental growth or the reasons for decline, in the last one and a half years, the biggest drag is actually coming from the large manufacturing sector and within that the commodities to such an extent that what used to contribute about 1.5-2% on incremental growth is actually on a minus 2% kind of a contribution right now.

I think in the last four quarters, steel companies have reduced their debt by probably Rs two lakh crores, (2 trillion). That is not a small number. My own sense is if we manage to do about about 8-8.5% odd this year – we are already running at probably 8.2% roughly as of the last date and hopefully if we can reach closer to 8.5% – then looking at how much we lost in retail last year, services segment a bit more and if we unwind from that; getting from 8.5% to 11% should not be a big challenge.

Is the market expecting it? Perhaps no. Markets are probably looking at 10-10.5%. My own expectation is probably 11-11.5%. We can possibly say I am a little bit more optimistic.

One of the key themes in the banking space for some time has been issues of corporate governance. How is the sector evolving in terms of the regulatory spotlight on corporate governance?
It is working on both sides. There is a lot of red ink that has come through because of the multiple failures and I want to be a little cautious when I am saying this but somebody is at fault.

RBI – given what has happened in the last four years roughly – is bound to take some action and when regulators act, they do not act with a scalpel. They work with an axe. And I think that’s what has happened. What has probably helped is it is like in a low tide, one can figure out who’s swimming naked. And if there is no growth, two things are possible because if there is no growth; banks, NBFCs, whichever…


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