Andy Mukherjee is a Bloomberg Gadfly columnist covering industrial companies and financial services. He previously was a columnist for Reuters Breakingviews. He has also worked for the Straits Times, ET NOW and Bloomberg News.

Hard to say if it was foresight or dumb luck, but Temasek took the right call on Indian lenders when it sold two-fifths of its 3.5 percent stake in ICICI Bank in February 2012. In Singapore dollar terms, and adjusting for a stock split, the Mumbai-based firm's shares have barely budged since. 

But soured corporate loans, which gutted Indian banks' profits and eroded their capital, are starting to peak. With that, the pall of gloom that had descended on the industry is lifting. Temasek, as Bloomberg News reported late Monday, is wetting its toes once again, taking an $18 million position in ICICI Bank's American depositary receipts.

Temasek's guarded optimism has company. The benchmark index for Indian banks has risen 39 percent since the end of February, when government-bond yields began to slide after trading in a narrow range for more than 12 months:

Debenture Boost
Falling bond yields have helped to lift Indian bank stocks
Source: Bloomberg

The correlation between soaring bank stocks and surging government bond prices is hardly a coincidence. The fatter the bond trading profit, the higher the opportunity for lenders to clean up their books faster than investors currently assume.

To see how, consider ICICI Bank's treasury income of $115 million during the last quarter. That's 12 percent more than the lender earned in the whole of the previous year.  State Bank of India booked $407 million in profit from sales of investments in the three months to June 30, 92 percent higher than the period ended March 31. As much as 39 percent of Bank of Baroda's non-interest income between April and June came from trading gains, versus 16 percent a year earlier.

In many ways, the bond market-driven improvement in Indian bank shares is reminiscent of the early 2000s. Then, too, a fixed-income rally was a helpful source of profit for lenders struggling to write off bad loans, especially advances made to an overcapacity-plagued metals industry:

This Movie Has Played Before
A bond market rally helped boost Indian banks' trading profits and share prices in the early 2000s
Source: Bloomberg

But lenders can't rely on the bond market alone. Corporate credit demand remains weak, leaving retail lending as the main source of earnings. And while State Bank of India's nonperforming loan pile grew by just $500 million in the June quarter, compared with a $3.8 billion buildup the previous three months, that may be partly because the troubled steel industry is enjoying a high degree of government protection from cheap imports. In reality, steel mills are neck deep in debt and a sustainable improvement in their repayment capacity might be a ways off.

For now, investors' main expectation from Indian banks is that they might deliver less bad news in future. Or at least that's what Temasek's cautious re-entry appears to suggest.

Yawning Gap
Indian banks' return on equity has fallen way below emerging-market peers
Source: Bloomberg

Still, the industry's average return on equity has collapsed to just 8.6 percent -- dismal in comparison to 13.4 percent for the MSCI Emerging Market Banks Index. Even if the worst is over for Indian lenders, that gap won't get closed in a hurry.

This column does not necessarily reflect the opinion of Bloomberg LP and its owners.

  1. Stripping out the 33.74 billion rupee ($504 million) profit that ICICI Bank made from selling stakes in two insurance ventures, treasury income in FY2016 was 6.86 billion rupees.

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Andy Mukherjee in Singapore at

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