Public Sector banking
After Independence of mother India, for planned economic growth, the financial system was established using the Banking system. Nationalisation of Banking took place in 1969 and in next two decades, Public Sector Banks(PSB) were catering for 90% of the banking business. PSBs were majorly concentrating on meeting the social obligation of countries development and there was a need for the efficient financial sector. Reforms based on internationally accepted practices were put in to practice from the year 1992-93.
The emphasis on maintenance of capital adequacy and compliance with the requirement of asset classification and provisioning norms has put severe pressure on the profitability of PSBs. Deregulation of interest rates on deposits and advances has intensified competition and PSBs have to now contend with competition not only from other public sector banks but also from old/new private sector banks, foreign banks, and financial institutions. Above all, with the growth of the capital markets, sound corporate clients now have the option of raising funds at lower cost by accessing capital markets for their equity as well as debt requirements.
As per Committee on Banking Sector Reforms (CBSR) headed by Shri M. Narasimham criteria for identifying weakness of the banks would be
a) Where accumulated losses and net NPAs exceed the net worth of the bank or
b) One whose operating profits less the income on recapitalization bonds has been negative for three consecutive years.
Seven parameters for assessing a bank’s strength/weakness covering three major areas are
1.Capital Adequacy Ratio (CAR)
2.Coverage Ratio (CR)
3.Return On Asset(ROA)
4.Net Interest margin(NIM)
5.Ratio of operating profit to average working funds
6.Ratio of cost to income
7.The ratio of staff cost to NIM+ All other income.
A study of these ratios in respect of a bank, historically or in comparison with its peers will give a clear view of its growing strength or weakness over a period as also of its ability to compete against others in the market.
Major Reasons for the recent crash in PSBs stock price can be attributed to:
1)Crony Capitalism: Loan was sanctioned with improper Debt to equity ratio, to favor individuals and companies. Losses due to these bad loans, termed as Non-Performing Asset(NPA) is pinching the
2)Disproportionate Corporate Debt Restructuring (CDR): Corporate debt restructuring is a specialized institutional mechanism for restructuring large exposures involving more than one lender under consortium/multiple banking arrangements.
Optimistic Picture – Pessimistic Future
The industry is expecting Rs.70000 crore planned capital infusion in the budget 2016-17 by Finance minister Shri. Arun Jaitley. Sad story over past 15 years is, more than Rs.81000 crore capital in PSBs has been eroded by NPA and CDR. It appears to be difficult for the Govt. to divest its stake in PSBs and raise money from the public. We all know that, whenever public was not interested to support Govt offloading its stake, Life Insurance Corporation of India (LIC) has come to rescue, which is not the right way of generating capital. Recapitalization may give Band-Aid solution to the wound and definitely, it’s not going to help re-rating the stocks.
Problems ahead of Public Sector Banks
1.Wage revision as per 7th pay commission may increase staff cost.
2.Poor asset quality leading to more NPA in upcoming quarters
3.Basel III norms are due to be implemented
Opinion about investing in Public Sector Bank shares at current levels
Majority of the bank has reported the loss in their Q3 results and it appears to be a trailer. Speedy resolution by RBI, towards cleaning financial sector, will impose banks to show stressed assets. If that happens Q4 results may be a disaster. As wise men say, it’s not advisable to catch the falling knife. Being intelligent investor one has to look into the value of the underlying script, not solely on the price.
PS: Special thanks to my friend Mr. Arun for invoking me to explore this topic:-)
Note: Banking sector fundamental knowledge represented here is gained from various RBI Publications, various leading news paper articles. Info credit goes to the respective information source.