Indian Banking Splinters

State-run lenders, as well as Axis, will remain in the doghouse for at least a couple more years.
Photographer: Dhiraj Singh/Bloomberg
As of 12:13 AM EDT
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When Moody's Investors Service polled market participants in Hong Kong recently, 70 percent picked India's banking system as the most vulnerable among seven countries in South and Southeast Asia. I wonder what the remaining 30 percent were smoking.

As another earnings season rolls on, the weaknesses of Indian lenders -- depleted capital levels in state-run banks and an inability to shed soured corporate debt even in non-state-controlled ones -- are once again obvious. What's not as apparent, though, is an quadrifurcation of Indian banking.

Axis Bank Ltd., one of the embattled lenders from the second category, dropped almost 3 percent on Wednesday after it reported a $546 million addition to its nonperforming assets in the June quarter. Were it not for an unusually large write-off of $380 million of hopeless debt, fresh slippages would have made the bank's $3.4 billion bad loan pile even bigger.

That's just the reported nonperforming assets, which now comprise 5 percent of Axis Bank's loan book. Loans on the bank's internal watch list, plus accounts that have been restructured, mean another 4.1 percent of the book is stressed, according to Nirmal Bang Institutional Equities.

Worse, for the fourth straight quarter, more than half of the lender's operating profit was spent on making provisions. An investor who had only seen a graph of provisions at Axis between 2006 and 2015 would have expected such hemorrhaging of profit to never occur.

Deluge of Delinquencies

Axis Bank's provision for loan losses as a ratio of pre-provision profit has been, for four straight quarters, at least four standard deviations higher than the past decade's average

Source: Bloomberg

Some corporate lenders, though, are faring better. Yes Bank Ltd., which spooked the market three months ago when it was forced by the regulator to disclose a chunky bad loan to an infrastructure firm, has managed to recover 60 percent of that money. Bad loans at Yes are down to less than 1 percent of the total, the lender announced Wednesday.

The contrast in performance of Axis and Yes shows bankers can't shift the blame to things they can't control, such as a multiyear funk in corporate profitability that has made Indian borrowers' capacity to service debt the worst in Asia. A quarter of the loan book at Yes is exposed to what the lender describes as sensitive: power; iron and steel; engineering; and telecoms. Yet, Yes is boxing on, while Axis is boxed in.

Lender Leaders

Yes Bank and HDFC Bank have both returned almost 50 percent this year

Source: Bloomberg

The bank that's leaving both Axis and Yes -- and everyone else -- behind is HDFC Bank Ltd. The retail-focused lender took a knock in the June quarter because of the distress in farm markets triggered by New Delhi's decision in November to outlaw most of the bank notes in circulation. As politicians rushed to announce waivers of agricultural advances, farmers strategically defaulted on their obligations.

While that pushed up HDFC Bank's bad-loan ratio to 1.24 percent, Managing Director Aditya Puri paid the higher credit costs and still delivered a net interest margin of 4.4 percent in the June quarter, beating Yes Bank's 3.7 percent and Axis's 3.3 percent.

Capital Needed

Stressed assets are now higher than Indian lenders' net worth. But with provisioning still inadequate, selling assets below book value will need fresh capital from the government

Source: McKinsey & Co.

India's banking industry is splitting four ways. State-run lenders, as well as Axis, will remain in the doghouse for at least a couple more years. HDFC Bank will steal their best corporate clients and add them to its formidable retail franchise.

Lenders like Yes and IndusInd Bank Ltd. fall somewhere in-between. They have few constraints on growth, but managing their existing exposure to large firms with weak profitability will be taxing.

The real opportunity lies in bite-sized loans. This prize, however, might go to specialists like Au Small Finance Bank Ltd., which went public earlier this month. Bernstein analyst Gautam Chhugani expects Au to quadruple its loan book in five years, mainly by lending to tiny businesses that have never had any access to finance.

The gloomy sentiment captured by the Moody's poll is still the biggest drag on Indian banking because of the sheer size of bad debt: $191 billion and counting. But for investors placing longer-term bets, it's the other three corners of the industry that deserve more attention.

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

    To contact the author of this story:
    Andy Mukherjee in Hong Kong at amukherjee@bloomberg.net

    To contact the editor responsible for this story:
    Katrina Nicholas at knicholas2@bloomberg.net

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