Banks's profits to decline further in 2007-08

New Delhi, Sept 9:ore profitability of Indian banks is likely to decline by 1.4 per cent in 2007-08, compared with 1.6 per cent in the previous year due to increase in the repo rates by 175 basis points(bps) and hike in cash reserve ratio (CRR) by two per cent, a study says.

It points out the core profitability of Indian banks has fluctuated in recent years. During the period 2000-01 to 2004-05, banks reported increase in profitability margins, backed by steady interest spreads, reducing operating expenses, and stable, though low fee-based incomes.

The net profitability margin (NPM) of the banking system touched the peak level over a decade of 1.83 per cent in 2004-05.

However, reversing a long trend of improving profitability margins since 2000-01, banks' core profitability declined in 2005-06, and recovered some lost ground in 2006-07.

These fluctuating fortunes are expected to continue in 2007-08, with another decline in profitability appear to be high likely, the study states and estimates that banks' core profitability levels will decline by 20 bps to 1.4 per cent levels in 2007-08.

The Crisil study conducted for FICCI says that the monetary measures taken by the Reserve Bank of India, such as increase in the repo rates by 175 bps in the last couple of years and hike in cash reserve ratio (CRR) by two per cent, have increased the overall cost of resources for banks.

The cost of deposits witnessed a sharp increase by about 60 basis points in 2006-07.

Further, excess SLR, now at around three per cent levels, is no longer sufficient to fund credit growth. Given this situation, the banks' scramble to mobilise deposits to fund the high level of credit growth is bound to push the cost of resources northwards in 2007-08.

The study feels that a softer interest rate regime which could be triggered either by apex bank lashing repo rates or proposed a cut in the RBI-mandated SLR investments limit could provide a much needed breather to banks and help improve their core profitability levels.

The study notes that asset quality of Indian banks has, however, improved consistently over the past seven years, with a steady decline in non-performing assets, both in absolute terms and as a percentage of total advances. The improved asset quality is demonstrated by the fact that more than half of the banking system's top 100 corporate borrowers today are in high safety rating categories ('AA' and 'AAA').

Robust corporate performance in recent years has stimulated the ambitions of Indian companies to grow rapidly through acquisition and capacity expansion.

These plans are increasingly being funded through debt, with the resulting possibility of deterioration in credit risk profiles, and stress on banks' corporate loan portfolios.

Banks, on the other hand, are diversifying their advances portfolio in favour of the higher-yielding retail and housing segments.

Though this diversification of the advances portfolio has augmented overall credit quality, it has resulted in increased exposure to relatively risky retail loan segments such as unsecured personal loans and consumer durables finance; these segments have historically reported high delinquency levels.

The study feels that though the inherent asset quality of the banking system has significantly improved, strong credit growth may bring its own risks, which could impact asset quality.

In the face of rising expansions and acquisitions in the Indian corporate sector and the current high-interest rate scenario, banks' corporate portfolios may face some stress.

Further, considering the increasing competition in the retail asset segment and most banks' being on a quest for higher yields in retail loan segment, it believes that the gross NPA and weak assets of the banking system will increase marginally.

The key factors that will enable improved asset quality would be adequate internal controls, strong risk assessment ability and an efficient collection process, the study claimed.

Banks' credit growth, the study says, though reined in somewhat in recent months, is expected to remain high at about 25 per cent in 2007-08. The proportion of bulk deposits will continue to grow, but at a slower pace, and it is expected that banks would gradually shift their focus towards retail term deposits.

Current and Savings Account (CASA) levels are likely to reduce marginally across the banking system over the medium to long term, with increasingly sophisticated depositors opting for higher-yielding investments.

The systemic cost of deposits will be also be driven by the structure of the resource mix, and not solely by the interest rate environment. The war for resources is, thus, expected to continue into the medium term.

As for capital adequacy, the study feels that the final guidelines issued by the RBI on the new capital adequacy framework under Basel II will bring about a sharp change in capital adequacy levels in the banking industry, as far as credit risk is concerned.

With respect to corporate loan books, public sector banks are set to gain more than private sector banks; this gain will accrue if the banks get their loan portfolios rated.

It is estimated that on an average, the banks will need to get anywhere between 25 to 50 credits rated to bring about a reduction in risk-weighted assets (rating of borrowers is also a prerequisite for Credit Default Swaps transactions, recently approved by RBI).

On the retail housing front, the capital adequacy of the entire industry could be impacted, because of aggressive underwriting standards during the recent mortgage boom, the study adds.

UNI