Indian banks’ profitability, already at the lowest since 2009, is poised to decline further after measures to stem the rupee’s record slump drove up borrowing costs and exacerbated rising bad loans and slowing loan growth.
Return on equity, which measures profit generated with shareholders’ funds, may fall below 10 percent in the year to March for banks from last year’s 12.8 percent, said Vibha Batra, co-head of financial-sector ratings in New Delhi at a unit of Moody’s Investors Service. Stressed assets are approaching levels last seen in 2002, she said on Aug. 21.
India’s banking index, which tracks lenders including State Bank of India, has lost 19 percent since July 15 following liquidity tightening measures from the central bank, which caused interbank rates to surge to a 17-month high last week. Those steps may drive up the risk of defaults in an economy that expanded last year at the weakest pace in a decade.
“With the rise in interest rates, the cash crunch and forex volatility, the evolving operating environment for banks in India is worrying,” Batra said. “With the operating environment becoming tougher, stressed assets in the banking system are rising.”
Interbank funding costs jumped after the Reserve Bank of India raised two interest rates and capped cash injections into the banking system to stem the rupee’s 19 percent slide against the dollar since the end of April.
The rupee’s slump is part of a sell-off in emerging-market assets as growth in the biggest developing nations slow and speculation increases the U.S. will start tapering its stimulus program. The MSCI Emerging Markets Index of stocks slumped 2.7 percent last week, the most in two months, while a gauge of a currencies in Brazil, Russia, India, China and South Africa touched its lowest level versus the dollar since June 2010.
The rate at which Indian banks lend to each other for three months climbed to 11.2 percent on Aug. 23, the highest level since March 2012, compared with 8.52 percent at the end of June, National Stock Exchange of India Ltd. data show.
The RBI’s attempt to check the rupee’s slide threatens to curtail lending that has already slowed in an economy that expanded 5 percent in the year ended March 31. Loan growth at Indian lenders fell to 13.7 percent in the 12 months to June 14, the lowest since December 2009, before rising to 16.6 percent as of Aug. 9, central bank data show.
“We reduced our exposure to Indian banks in recent months,” David Gaud, a Hong Kong-based senior portfolio manager at the asset management unit of Edmond de Rothschild Group, which oversees more than $157 billion, said by phone on Aug. 21. “Nonperforming assets will rise and loan growth will be slower. There will be further pressure on return on equity.”
HDFC Bank Ltd. had an ROE of 20.6 percent, the most among India’s 10 largest banks, while state-run IDBI Bank Ltd. had the lowest, according to data compiled by Bloomberg. State Bank of India, the nation’s largest by assets, had an ROE of 13.59 percent at the end of March, according to an e-mail from the lender’s public relations department.
IDBI’s ROE had fallen to 6.3 percent as of June 30 from 10.1 percent a year earlier due to higher provisioning for soured debt and restructured assets, Chief Financial Officer Pothukuchi Sitaram wrote in an Aug. 23 e-mail.
The S&P BSE Bankex Index, a gauge for 13 lenders, gained 0.2 percent in Mumbai today. HDFC Bank rose 0.6 percent and State Bank of India fell 0.1 percent. IDBI advanced 0.6 percent.
Bad loans in the banking system rose to 3.92 percent of total lending as of June 30, the highest in at least five years, from 3.4 percent at the end of March, according to central bank data.
The stressed-asset ratio, which measures bad loans and restructured assets as a percentage of loans, was at 10.02 percent at the end of June, central bank data show. The measure is approaching 10.4 percent, a level last seen in 2002, said Batra, who works at rating company ICRA Ltd.
To ease the cash crunch, the RBI will buy 80 billion rupees ($1.25 billion) of long-dated government debt, the authority said after markets closed on Aug. 20, a day after India’s 10-year bond yield reached the highest level since 2001.
“The central bank may take more measures,” Alex Mathews, head of research at Geojit BNP Financial Services Ltd. said by phone on Aug. 22. “Easing the cost of funds can help in reviving the economy and improve the profitability of banks.”
Mathews, who doesn’t have official ratings on India’s lenders, is recommending his clients to gradually accumulate ICICI Bank Ltd., Axis Bank Ltd., Yes Bank Ltd. and HDFC Bank as their share prices drop.
The Bankex Index surged 6 percent at the open on Aug. 21 before paring to close 0.5 percent higher as foreign investors sold a net $118 million of Indian equities, according to data compiled by Bloomberg. That was the fourth straight day of sales, the data show. The rupee has fallen 1.4 percent since the RBI’s action and was recently at 64.10 per dollar.
“The recent measures by the central bank to ease liquidity are not changing the operating environment,” Dolly Parmar, Mumbai-based banking analyst at IFCI Financial Services Ltd. said by phone on Aug. 23. “The concerns will remain until the rupee stabilizes and the economy grows at a faster rate.”
Parmar has buy ratings on HDFC Bank and ICICI, and recommends investors sell Union Bank of India and Bank of India.
Union Bank and Canara Bank, which are both state controlled, have fallen more than 50 percent this year. The two are the Bankex’s worst performers in that period amid concern growth in bad loans at government banks will outpace private sector lenders, Geojit’s Mathews said.
The gross bad-loan ratio at India’s state-run banks was 3.8 percent as of March 31, compared with 1.91 percent at private sector lenders, central bank data show.
Investors are demanding a higher premium to hold the debt of Indian banks. The yield on State Bank of India’s 4.5 percent euro debt due in September 2015 rose 79 basis points this month to 3.59 percent, heading for the biggest increase since September 2011, according to data compiled by Bloomberg.
India may delay injecting capital into government banks including IDBI and Dena Bank because of the slump in their stock prices, Rajiv Takru, the finance ministry’s banking secretary, said in an Aug. 19 interview. The government, which usually puts capital into lenders by buying their shares, doesn’t want to lose money as prices slide, Takru said.
Moody’s downgraded the financial strength ratings of three state-run lenders -- Bank of Baroda, Canara Bank and Punjab National Bank -- to negative from stable on Aug. 16, reflecting the “challenges” of the current economic environment that had been exacerbated by the weakening rupee. Shares of the three banks have slumped at least 1.8 percent since then.
The RBI measures to support the currency have not reversed the depreciation, implying interest rates may remain elevated, Moody’s said in a statement. State-controlled lenders will have more difficulty responding to slower economic growth and declining margins, it said.
“Until the rupee volatility subsides, banks’ profitability will keep falling,” IFCI’s Parmar said. “Banks will feel more pain in coming months.”