Banking Industry Analysis: RoA, NIMs, Yields, Costs, NPAs

Analysis of Banking Industry
Industry Structure : 4
Business : 23
Advances : 27
Deposits : 46
Investments : 61
NPAs : 69
Operating Expenditure : 88
Net Profitability Margins : 101
Interest Earned & Extended : 108
Other Income : 122
Spreads : 131
Application Of Banking Licenses : 145
ARC : 149
Basel 3-Analysis : 220
Future Outlook : 251
Table Of Contents
Industry Structure
Return on Asset to fall in 2013-14 and remain at low levels in 2014-15
CRISIL Research expects banks' Return on Asset (RoA) to decline
to 0.7 per cent in 2013-14 from an estimated 1.0 per cent in 2012-
13.
The decline will be largely due to the poor performance of public
sector banks who are projected to have 0.5 per cent RoA by March
2014.
We expect that RBI's guidelines on restructuring of advances by
banks and financial institutions would increase provisioning of
banks by Rs 150 billion over April 2013 - March 2015.
A major portion of this incremental provisioning will have to be
done by public sector banks (PSBs), which together accounted for
95 per cent of the restructured assets of the banking system as of
June 2013.
RoA will remain at low levels in 2014-15 as Non-performing
assets (NPAs) are expected to remain at an elevated level for
public sector banks (PSBs).
However, we expect private sector banks to see an
improvement of ~10 basis points in RoAs in 2014-15 due to
better efficiency as well as a strict credit appraisal mechanism.
Return on Asset to fall in 2013-14 and remain at low levels in 2014-15
Return on Asset
Net interest margin
Net interest margins (NIMs), on the other hand, will decline by 15-20
bps over 2013-14, due to the rising cost of funds and rising NPAs.
Net interest income for public sector banks has grown at half the rate of
growth in advances.
The significant variation is mainly on account of a substantial rise in
non-interest earning assets (GNPA as well as restructured loans, which
account for about 11 per cent of advances) and further aggravation on
account of pricing pressure.
While the CASA deposit base is expected to shrink, rising non-earning
assets (Gross NPA) will severely impact profitability of banks.
Both the bank groups will witness pressure on NIMs but, the drop in
NIMs of PSBs is expected to be more sharper than that of private banks.
Net interest margin
This is because, many private banks have raised their base rate
in response to the rising cost of funds, while public sector banks
are not expected to do so any time soon.
Also, the gross NPA in case of public sector banks is expected to
move up at a much faster pace than private banks.
However, we expect NIMs to improve by 5-10 basis points in
2014-15 on the back of economic recovery and better pricing
power of banks.
Net interest margin
Net Profitability Margins - Banking system
Net profit margins will be affected by:
Yield on advances
With a 100 bps cut in the repo rate during 2012-13, banks also cut
their base rate by up to 50 bps (modal base rate).
As majority of the assets are floating (variable) in nature, the
yield on advances too declined marginally.
With inflation expected to remain high in 2013-14 and 2014-15,
growth in deposits forecast to remain low and no further scope
for repo rate cuts, yields are likely to inch up marginally.
The base rate of PSBs is not expected to go up much.
However, a few private banks have hiked their base rate by up to
25 bps, post the liquidity tightening measures initiated by the RBI
in July 2013.
Trend in yield on advances
Yield on investments
Yields from investments made by banks hinge upon a mix of
trade and non-trade strategic investments, the maturity profile
of these investments and the interest rates prevalent at the
time of issuance of securities as well as at the time of maturity.
However, for banks, almost 75 per cent of the portfolio is
classified as Held-To-Maturity (HTM).
Thus, the short-term fluctuation in rates is unlikely to have a
significant impact on the profitability of banks as such
securities are not marked to market.
Maturity profile of investments of scheduled commercial banks
Almost 43 per cent of investments of scheduled commercial
banks (SCBs) is in the over 5-year maturity bucket.
A large proportion of these investments are likely to be strategic
in nature, including investments in subsidiaries.
As of March 2013, about 30 per cent of investments were short-
term (with maturities of less than 1 year), 14 per cent were in the
1-3 years bucket, and 13 per cent were in the 3-5 years maturity
bucket.
The yield on investments is expected to decline by 30-40 bps in
2013-14, as G-Sec yields fall.
G-Sec yields are expected to remain at similar levels in 2014-15.
Cost of deposits
Bank deposits comprise current deposits, savings deposits and
term deposits.
Current and savings account (CASA) deposits are low-cost
deposits.
While banks do not offer interest on current account deposits,
interest on savings deposits have been deregulated by the RBI
since October 2011.
Interest rates on term deposits are determined by individual
banks based on the tenure.
When credit offtake is high and competing investment avenues
such as mutual funds, stock markets and post office savings offer
attractive returns, banks tend to increase rates on term deposits to
attract customers.
Maturity profile of term deposits with scheduled commercial banks
In response to rise in short-term market rates and slowing growth
in deposits, banks have increased their deposit rates by 25-50 bps
across maturities over the last 6 months.
The full effect of this would be felt in the near term as the hike in
rates has taken place mainly for the shorter maturities.
Consequently, the cost of deposits is expected to remain at
elevated levels of 6.5 and 6.4 per cent in 2013-14 and 2014-15,
respectively .
In the medium term, term deposit rates are likely to stay high, as
deposit growth remains tepid.
Maturity profile of term deposits with scheduled commercial banks
Cost of deposits for SCBs
Cost of borrowings
As in the case of advances, most bank borrowings are raised on a
floating-rate basis.
Banks borrowings are raised primarily to fix liquidity mismatches,
and hence, are mostly short-term in nature.
CRISIL Research's analysis of maturity profile indicates that 55-60
per cent of borrowings have a tenure of less than 1 year.
Based on the proportion of borrowings from various sources
and the movement in rates for each source, the cost of
borrowings is estimated to decrease only marginally in 2013-14
and 2014-15 as market rates have declined post RBI easing some
of the liquidity tightening measures.
Cost of borrowings
Business
SCBs' business grew at a healthy pace from 2007-08 to 2012-13
The business (advances plus deposits) of scheduled commercial
banks (SCBs) grew at a CAGR of about 18 per cent to Rs 133,134
billion in 2012-13, from Rs 57,971 billion in 2007-08.
Public-sector banks remained the major growth driver, with a 77
per cent share in SCBs' total business as of 2012-13.
Bank group-wise share in total business
PSBs lead the pack
Advances
Advances by PSBs grew the fastest over past 5 years
Total advances of scheduled commercial banks (SCBs) grew at a CAGR
of 18.9 per cent to Rs 58,815 billion in 2012-13 from Rs 24,770 billion in
2007-08.
However, on a year-on-year (y-o-y) basis, growth in advances slowed to
16 per cent (from 18 per cent in 2011-12) due to lower credit offtake by
almost all productive sectors such as agriculture, industry and services.
Agriculture and allied activities recorded the sharpest slowdown.
Working capital loans grew at a CAGR of 21.2 per cent from 2007-08 to
2012-13, while term loans recorded a 17 per cent CAGR.
However, on a y-o-y basis, growth in term loans slowed to 14 per cent in
2012-13 from 17 per cent in 2011-12 owing to sluggish growth in the
economy, shelving of capital expenditure plans by companies and risk
aversion by banks (on account of rising NPAs).
During the year, the share of working capital loans in total
advances marginally increased to 46.3 per cent from 45.3 per cent
a year ago as the working capital cycle for the companies is
getting longer on account of an increase in debtor and inventory
days amidst a slowdown in the overall economy.
Advances by PSBs grew the fastest over past 5 years
Overall break-up of advances
Public-sector banks
Advances of public sector banks increased at a CAGR of 20 per
cent between 2007-08 and 2012-13 to Rs 44,756 billion.
Of this, term loans grew at a CAGR of 18.3 per cent, while working
capital loans grew at a CAGR of 22 per cent.
However, on a y-o-y basis, a deceleration in term loan led to an
overall sluggish credit growth.
Overall growth in advances slowed to 15 per cent in 2012-13 (from
17 per cent a year ago), while growth in working capital loans
accelerated to 18 per cent from 16 per cent in 2011-12.
Consequently, the share of working capital loans in total advances
increased to 48 per cent in 2012-13 from 47 per cent in 2011-12.
Break-up of advances
Private sector banks
Advances by private sector banks grew at a CAGR of 17.1 per cent to
Rs 11,433 billion in 2012-13 from Rs 5,184 billion in 2007-08.
Of this, working capital loans grew at a CAGR of 20.8 per cent, while
term loans grew at a CAGR of 15.4 per cent.
However, on a y-o-y basis, overall growth in advances slowed to 18
per cent in 2012-13 from 21 per cent in 2011-12.
While working capital loans grew by around 27 per cent in 2012-13,
term loans grew only by 14 per cent in 2012-13.
The share of working capital loans increased to 36 per cent in 2012-13
from 33 per cent in 2011-12, while the share of term loans declined to
64 per cent in 2012-13 from 67 per cent a year ago.
At 18 per cent y-o-y growth in 2012-13, private banks grew at a
faster pace than their public sector and foreign counterparts,
largely owing to:
1. Better marketing focus in terms of products
2. Opening of larger number of branches as compared to public
sector and foreign banks
3. Base effect
Foreign banks
Over 2007-08 to 2012-13, total advances by foreign banks grew at a
CAGR of 10.3 per cent to Rs 2,636 billion in 2012-13, from Rs 1,611
billion in 2007-08.
Working capital loans registered a CAGR of 14 per cent during the
same period, while term loans recorded a CAGR of only 6 per cent.
On a y-o-y basis, growth in advances slowed to 15 per cent from 18
per cent in 2011-12.
However, growth was driven by a 17 per cent rise in working capital
loans and 11 per cent increase in term loans.
The share of working capital loans in total advances of the group
increased to 60 per cent in 2012-13 from 59 per cent in 2011-12, while
the share of term loans declined from 41 per cent in 2011-12 to 40 per
cent in 2012-13.
Priority-sector advances
Credit to priority sectors has received a boost from the Reserve Bank
of India's (RBI's) initiatives in recent years.
The priority sectors comprises of agriculture, small-scale industries
(SSI), education and housing.
Targets and sub-targets under priority sector lending are linked to
the adjusted net bank credit (ANBC) or credit equivalent amount of
off-balance sheet exposure (CEOBSE).
In August 2011, the RBI set up a committee under Shri M V Nair to
re-examine the existing classification and suggest revised guidelines
pertaining to priority sector lending.
The broad recommendations of the committee were adopted by the
RBI in July 2012.
Under the revised guidelines, there was no change in the overall
target of the priority sector.
However, with the growing presence of foreign banks in India,
the priority sector lending target was increased for a specific
segment of foreign banks from 32 per cent to 40 per cent, at par
with domestic banks.
Priority-sector advances
Priority-sector lending targets
Priority-sector lending targets
Group-wise trends in priority-sector advances
Foreign banks recorded the highest growth of 28 per cent in
priority-sector advances in 2012-13.
Total priority sector advances by foreign banks accounted for
35.2 per cent of their ANBC (as compared with 41 per cent last
year), which was above the prescribed target of 32 per cent set
by the RBI.
Advances to priority sector by public sector banks
Advances to priority sector by private sector banks
Advances to the priority sector by foreign banks
Note: With effect from April 30, 2007, the targets and sub-targets under priority-
sector lending have been linked to ANBC [Net bank credit (NBC) plus investment
Deposits
Steady growth in deposits in 2012-13
Growth in overall bank deposits was about 15 per cent y-o-y in
2012-13, similar to the growth rate in 2011-12.
This growth in deposits was largely driven by the revival in the
growth of current and saving accounts (CASA) deposits in 2012-
13.
The growth in CASA deposits accelerated to 15 per cent (as
against 8 per cent in 2011-12), reaching Rs 24,724 billion.
Within CASA deposits, current deposits increased by 13 per cent
y-o-y, while savings deposits grew by about 15 per cent y-o-y.
This can be partly attributed to the improved competition among
banks, thereby offering attractive rates on savings deposits
(especially for private sector banks).
Overall break-up of deposits
The composition of deposits remained almost similar, with the
share of CASA deposits at 33 per cent in 2012-13.
However, the share of term deposits in total incremental
deposits declined significantly to 68 per cent from 80 per cent
in 2011-12, while the share of CASA in total incremental
deposits increased to 32 per cent in 2012-13 from 20 per cent in
2011-12.
Overall break-up of deposits
Overall growth in total deposits and share of low-cost deposits
Public-sector banks
Public-sector bank deposits grew at a CAGR of 19 per cent between
2007-08 and 2012-13 to Rs 57,451 billion.
On a y-o-y basis, however, growth remained similar to the previous year
at 14 per cent.
Break-up of deposits
Term deposits registered a slower growth of 15 per cent in 2012-
13 in comparison with 18 per cent in 2011-12.
CASA deposits grew by 15 per cent in 2012-13, within which,
savings deposits rose by 14 per cent (against 12 per cent in the
previous year), while current deposits grew by 17 per cent
(versus a decline of 6 per cent in the previous year).
Growth in total deposits and share of low-cost deposits
Private sector bank deposits grew at a CAGR of 16 per cent to
Rs 13,956 billion in 2012-13 from Rs 6,751 billion in 2007-08.
On a y-o-y basis, the group registered the highest growth of 19
per cent in 2012-13 among all bank groups, which can be partly
attributed to the fact that some private banks revised their
savings bank deposit rates upward after the deregulation of
savings bank interest rates by RBI in October 2011.
Growth in current deposits and savings deposits increased to 15 per cent
and 19 per cent in 2012-13, respectively, (from 4 per cent and 18 per cent,
respectively in 2011-12).
Growth in term deposits slowed marginally to 19 per cent in 2012-13 from
20 per cent in 2011-12.
Foreign banks
Foreign banks generally cater to high net worth individuals (HNIs) and
NRI deposits.
Besides, only very few banks, such as HSBC Bank, Standard Chartered
Bank, Citibank and ABN AMRO Bank, are involved in retail banking.
Over 2007-09 to 2012-13, growth in foreign banks' deposits was the lowest,
at a CAGR of 9 per cent.
On a y-o-y basis, however, growth was slower at about 4 per cent in 2012-
13 (as against 15 per cent in 2011-12).
Foreign banks generally prefer to cater to corporate clients
with sound cash management, who maintain current
deposits.
Over the past 5 years, current deposits grew at a CAGR of 5
per cent, while savings deposits grew at a 10 per cent CAGR.
The share of low-cost deposits declined to 41 per cent in 2012-
13 from 44 per cent in 2011-12 as a result of a 10 per cent y-o-y
rise in term deposits in 2012-13 as against a 4 per cent decline
in CASA deposits in 2012-13.
Investments
Banks parked more than three-fourth of their investments in
SLR securities
Growth in banks' total investments improved to 17 per cent in 2012-
13, from 16 per cent in 2011-12.
Investments by banks fall into two broad categories:
Statutory liquidity ratio (SLR) investments: Government securities
and other government-approved securities.
Non-SLR investments: Commercial papers, shares, bonds and
debentures issued by companies, units of UTI and other mutual
funds.
As per the Banking Regulation Act, 1949, banks have to invest a
prescribed minimum of their net demand and time liabilities
(NDTL) as liquid assets in government and other approved
securities. The ratio of liquid assets to NDTL is known as SLR.
As part of the financial sector reforms undertaken in the 1990s,
the SLR requirement for banks was gradually reduced to 25 per
cent in October 1997 from 38.5 per cent in February 1992.
In 2012-13, banks were required to invest around 23 per cent of
their net demand and time liabilities in SLR securities.
Banks parked more than three-fourth of their investments in
SLR securities
SLR investments
Scheduled commercial banks (SCBs)
As of 2012-13, almost 77 per cent of the banking sector's total
investments were in SLR securities, mainly to meet RBI norms and
to access the short-term money market.
Growth in SCBs' total investments accelerated in 2012-13.
The composition of these investments also changed with the share
of SLR investments falling to 77 per cent in 2012-13 from 78 per
cent in the previous year.
This was largely on account of a reduction in SLR requirement to
23 per cent from an earlier 24 per cent by the RBI in August 2012.
As the SLR requirement for banks was reduced by 100 basis
points during the year, it parked more funds in non-SLR securities
in order to earn higher returns.
Investment in SLR securities increased steadily
Public sector banks:
In 2012-13, growth in investments by public sector banks in SLR
securities slowed down to 13.5 per cent from 16 per cent in 2011-12.
Bank group-wise investment in SLR securities
Investment in SLR securities increased steadily
Bank group-wise investment in SLR securities
Private sector banks: In 2012-13, private banks' investments in
SLR grew by 18 per cent as compared to a 32 per cent rise in the
previous year.
Foreign banks: Foreign banks' investments in SLR securities
increased by 21 per cent as compared to a 23 per cent increase in
the previous year.
Non-SLR investments
The share of non-SLR investments in SCBs' total investments
increased to 23 per cent in 2012-13 from 22 per cent in 2011-12, as
investments in non-SLR securities increased by 24 per cent in
2012-13 versus just a 5 per cent rise in 2011-12.
This increase can be partly attributed to the rising investment of
banks in commercial papers, as corporations issued short-term
paper to raise money for working capital needs.
The composition of non-SLR investments of banks has changed in
recent years, since 2004-05.
The share of banks' investment in shares, commercial papers and
units of mutual funds has been growing, while the share of
investment in bonds/debentures has been declining, partly
reflecting the changing risk appetite of Indian banks.
NPAs
Banks' gross NPAs increased by 50 bps in 2012-13
As per the Reserve Bank of India's (RBI's) asset classification norms,
loan assets can be classified into four categories standard assets,
sub-standard assets, doubtful assets and loss assets.
The central bank has prescribed appropriate provisioning
requirements for each of these categories.
Of the above, sub-standard assets, doubtful assets and loss assets
together comprise non-performing assets (NPAs).
An NPA is a loan or an advance where the interest and/or
installment of principal remains overdue for a period of more than
90 days.
Indian banks' NPA levels have traditionally remained high on
account of archaic policies, industrial weakness, inefficient debt-
recovery laws and a high incidence of willful defaulters.
However, rapid economic expansion led to a steady decline in
the gross NPA ratio between 2004-05 and 2008-09.
Post 2008-09, NPAs started rising again, as the asset quality of
banks deteriorated.
Banks' gross NPAs increased by 50 bps in 2012-13
In 2012-13, overall gross NPAs for the industry increased by 50
bps y-o-y to 3.6 per cent due to the weak macroeconomic
scenario, sharp rise in interest rates, volatility in the currency and
commodity markets.
All these factors strained the cashflows of companies, resulting in
higher deterioration in the asset quality of banks.
SCBs
SCBs
Various laws have been enacted to help banks deal with bad loans.
Of these, the Securitisation and Reconstruction of Financial Assets and
Enforcement of Security Interest (SARFAESI) Act and Debt Recovery Tribunals
(DRTs) have been the most effective in terms of the amount recovered.
In 2012-13, the amount recovered by the SARFAESI Act was the highest.
NPAs recovered by SCBs through various channels
By the end of June 2013, the book value of bad loans acquired by
securitisation and asset restructuring companies (SCs/RCs)
registered with the RBI stood at Rs 885 billion, rising by 10 per
cent during July 2012 to June 2013.
While security receipts that were subscribed to by
banks/financial institutions amounted to Rs 189 billion, security
receipts redeemed amounted to Rs 101 billion for the year ended
June 2013.
Of the total amount of assets securitised by SCs/RCs, the largest
amount was subscribed to by banks.
However, their share has been declining continuously in recent
years.
NPAs recovered by SCBs through various channels
Details of financial assets securitised by SCs/ RCs
Bank group-wise performance
SBI and associates
The deterioration in asset quality was sharper for public sector
banks.
Consequently, the rise in gross NPAs was also faster than that of
the industry.
Various factors contributed to the deterioration of asset quality: a
worsening macroeconomic scenario, sharp rise in interest rates,
volatile currency and commodity markets and the adoption of
system-based NPA recognition that showed a sudden spike in
GNPAs in the small retail and agri-based loan portfolios.
For SBI and its associates, gross NPAs as a percentage of gross
advances increased to 5.0 per cent in 2012-13 from 2.6 per cent in
2007-08.
SBI and associates
The share of net NPAs in net advances also increased to 2.0 per
cent from 1.4 per cent.
The share of the SBI group in the industry's overall gross
advances declined to 23.3 per cent in 2012-13 from 24.3 per cent
in 2007-08.
Still, the group's share in overall gross NPAs increased to about
33.3 per cent in 2012-13 from 27.4 per cent in 2007-08.
SBI and associates
Nationalised banks
For this group, the proportion of gross NPAs to gross advances
increased to 3.6 per cent in 2012-13 from 2.1 per cent in 2007-08.
The net NPA ratio increased to 2.0 per cent in 2012-13 from 0.8
The share of nationalised banks in the total industry's gross
advances increased to 52.7 per cent in 2012-13 from 46.3 per cent
in 2007-08.
The proportion of gross NPAs of nationalised banks to gross
NPAs of all SCBs increased much faster to 52.7 per cent in 2012-
13 from 41.4 per cent in 2007-08.
Nationalised banks
The share of gross NPAs in gross advances improved to 2.0 per
cent in 2012-13 as compared to 2.5 per cent in 2007-08.
Net NPAs as a proportion of net advances also fell to 0.5 per cent
from 1.0 per cent.
The proportion of gross advances of private banks in the
industry's total gross advances declined to 19.5 per cent in 2012-
13 from 21.4 per cent in 2007-08, while the share of the group's
gross NPAs in that of the industry's declined to 10.8 per cent in
2012-13 from 23 per cent in 2007-08.
Foreign banks
In the past, stringent risk management practices have helped
foreign banks maintain the lowest NPA levels.
However, aggressive lending, especially during the global
financial downturn, led to a steep increase of 200 bps in the gross
NPA ratio to 3.8 per cent in 2008-09.
In 2009-10, the number increased further, though at a slower
pace, due to improved customer orientation, stringent credit
underwriting policies and collateral management standards.
Consequently, in 2010-11, the gross NPA ratio declined by about
172 bps y-o-y to 2.54 per cent.
In 2011-12 and 2012-13, the gross NPA ratio rose again
marginally to 2.6 per cent and 2.9 per cent, respectively.
Foreign banks
The share of foreign banks in gross advances of all SCBs declined
to 5 per cent in 2012-13 from 6.5 per cent in 2007-08.
Over the same period, the share of gross NPAs in the industry's
gross NPAs declined to 4 per cent from 5 per cent.
Foreign banks
Sector-wise NPAs
Priority sector NPAs, which had constituted 46 per cent of the
total NPAs of domestic banks in 2008-08, declined to about 41
The NPAs in the agriculture sector declined in 2008-09 mainly on
account of the implementation of the agricultural debt waiver
and debt relief scheme and witnessed an upward trend
thereafter.
For PSBs, between 2009 and 2010, the share of priority-sector NPAs with
respect to small-scale industries (SSIs) started increasing, partly due to
the impact of the financial crisis and the economic slowdown that set in
thereafter, resulting in stretched working capital for SSIs.
As of March-end 2013, the share of priority-sector NPAs in PSBs' total
NPAs was 43 per cent, while for private sector banks, the figure was 26
per cent.
Sectors that mainly contributed to higher NPAs were the priority sectors
such as agriculture, construction, metals (iron and steel), engineering,
aviation and infrastructure (specifically, power and telecom).
In 2012-13, the asset quality also deteriorated on account of the increase
in the share of the non-priority sectors in total NPA to 59 per cent from
53 per cent in the previous year.
Sector-wise NPAs
Sector-wise NPAs for different bank groups
Operating expenditure
Nationalised banks remained most cost-efficient in 2012-13
CRISIL Research has attempted to analyse the performance of
various bank groups with respect to staff costs and other operating
expenses.
VRS, technology upgradation helped SCBs reduce staff costs
Traditionally, staff costs as a percentage of total operating
expenditure have been significantly higher for public sector banks
(PSBs).
Hence, a voluntary retirement scheme (VRS) was initiated in the late
1990s to reduce staff costs.
However, the per employee cost of PSBs has continued to rise, given
the changing composition of staff and higher provisioning towards
superannuation liabilities.
In 2012-13, scheduled commercial banks' (SCBs') employee costs
increased by 12 per cent y-o-y against only 7 per cent growth in 2011-12.
The employee costs as a percentage of operating expenses for SCBs
declined to 55.7 per cent in 2012-13 from 56.7 per cent in 2011-12.
It was the highest for PSBs (63 per cent), while it was the lowest in case
of foreign banks (42.1 per cent).
We believe that staff costs should be viewed in conjunction with the
quantum of funds managed by the staff.
Hence, to analyse staff costs, we have compared the following ratios for
different bank groups:
1. Average advances/staff costs
2. Average funds deployed (AFD)/staff cost
VRS, technology upgradation helped SCBs reduce staff costs
Average advances/staff cost
Average funds deployed/staff cost
Group-wise performance
SBI and associates
Benefits from VRS, technology upgradation and focus on
computerisation of all branches have helped banks become more
cost-efficient in recent years.
During 2012-13, both, the average advances-to-total staff cost
ratio and the AFD-to-total staff cost ratio for this category
increased y-o-y.
However, core fee-based income as a percentage of total staff
costs fell to 74 per cent in 2012-13 from 82 per cent in 2011-12.
SBI and associates
Nationalised banks
The productivity of nationalised banks was the highest among all bank
groups in 2012-13 as average advances/staff cost as well as AFD/staff cost
increased in 2012-13 on account of a 15 per cent y-o-y growth in AFD.
The ratio of average advances-to-total staff cost for private
sector banks was the second-highest among all bank groups in
2012-13.
Private sector banks are more cost-efficient, as they have
smaller branch networks as compared to public sector banks.
Moreover, they invest heavily in technology, which helps them
reduce staff costs.
For example, an ATM, which is manned by just one person,
performs numerous basic banking operations.
Private sector banks also employ direct selling agents to source
prospective clients, which further cuts down staff
requirements.
Foreign banks
The productivity of foreign banks was the lowest among all bank
groups in 2012-13.
AFD/staff cost for foreign banks increased substantially in 2012-13,
largely due to a 23 per cent y-o-y growth in funds deployed as against
only a 5 per cent increase in staff cost.
High advertising costs drove up other operating expenses for
nationalised banks
All bank groups witnessed an increase in other operating expenses
(excluding staff costs) over the years.
The rise was the sharpest for nationalised banks, due to a large branch
network (52,480 offices).
Advertising costs have increased substantially as PSBs are now looking to
market their products through various media.
Postage and telephone expenses have also shot up.
In the coming years, operating expenses for this category are likely to
continue rising, as they increasingly focus on retail finance and venture into
other areas for diversifying their income.
On the other hand, though operating expenses of foreign banks rose the
least, they incurred the highest advertising expenses among all bank groups
(Rs 7.56 billion in 2012-13).
High advertising costs drove up other operating expenses for
nationalised banks
Net Profitability margins
SCBs' NPM declined by 21 bps y-o-y to 1.52 per cent in 2012-13
NPM - SCBs
CRISIL Research uses net profitability margin (NPM) to measure the
profitability of a lending business.
NPM is equivalent to the yield on carry business less cost of borrowings
plus non-fund (fee) income less operating expenses.
The SCBs' NPM declined by 21 bps y-o-y to 1.52 per cent in 2012-13.
The spread declined by 17 bps, while operating expenses to average funds
deployed (AFD) fell by 5 bps.
Core fee-based income as a percentage of AFD remained same.
This decline in the banks NPM can be attributed to a steep rise in the
interest expended by the banks during the year as well as high operating
expenses.
Moreover, competitive pressures and sluggish credit offtake limited the
banks' pricing power, thereby affecting their profitability.
SCBs' NPM declined by 21 bps y-o-y to 1.52 per cent in 2012-13
NPM - SCBs
SBI and associates
NPM - SBI and associates
The NPM of SBI and its associates declined by 44 bps y-o-y to 1.88 per cent in
2012-13.
The spreads declined by 31 bps y-o-y to 2.96 per cent in 2012-13.
The operating expense as a percentage of AFD and core fee income as a per cent
of AFD declined marginally by 2 bps and 15 bps y-o-y to 2.01 per cent and 0.93
per cent, respectively.
Nationalised banks
NPM - Nationalised banks
The NPM of nationalised banks declined by 17 bps y-o-y to 1.51 per cent in
2012-13, mainly because spreads declined by 17 bps, while core fee income
as a percentage of AFD went down marginally by 4 bps.
Operating expenses as a percentage of AFD fell by 4 bps to 1.45 per cent.
NPM - Private sector banks
The NPM of private sector banks registered a marginal decline of 2 bps from
2.75 per cent in 2011-12 to 2.73 per cent in 2012-13.
Their spreads registered an increase of 8 bps y-o-y in 2012-13 to reach 3.56
per cent.
An increase in operating expenses and decline in core fee income offset the
increase in spreads, resulting in a marginal decline in NPM.
Foreign banks
NPM - Foreign banks
The NPM of foreign banks declined by 91 bps y-o-y to 3.92 per cent in 2012-
13.
Spreads declined by 39 bps y-o-y to 4.71 per cent in 2012-13.
Operating expenses as a percentage of AFD declined by 26 bps in 2012-13 to
reach 2.77 per cent.
The core fee income as a percentage of AFD posted a steep fall of 78 bps,
dragging down the NPM of foreign banks.
Interest earned and exended
High interest rates spur rise in banks' total interest income
The total interest income earned by scheduled commercial banks
(SCBs) grew at a CAGR of 19.9 per cent between 2007-08 and
2012-13, aided by high interest rates and growth in advances (19
per cent CAGR).
Of the total interest income, interest on advances grew at a
CAGR of 20.7 per cent between 2007-08 and 2012-13, while
income on investments grew at a CAGR of 19 per cent due to an
increased investment by banks in SLR securities.
Other interest earned increased at a CAGR of 18 per cent, while
interest on balance with the RBI increased at a CAGR of 5 per
cent in the same period.
All SCBs
In 2012-13, interest income of the banks grew by 17 per cent y-o-y, a slower
growth as compared to 33 per cent growth in 2011-12.
The major reason for this was the slowdown in the credit growth for banks.
Also, interest rates which had hardened during earlier years started
softening during the period.
SBI and associates
The total interest income of SBI and its associates grew at a CAGR of 18.4
per cent between 2007-08 and 2012-13 due to 19 per cent CAGR in interest
on advances for the same period.
Income on investments grew at a CAGR of 16 per cent.
However, the interest on balances with the RBI declined by 6.4 per cent,
while other interest earned rose by 14 per cent between 2007-08 and 2012-
13.
Nationalised banks
The total interest income of nationalised banks grew the most among all
bank groups at a CAGR of 22.4 per cent between 2007-08 and 2012-13.
This growth was mainly aided by a 23.5 per cent CAGR in interest on
advances.
Income on investments grew at a CAGR of 19.5 per cent between 2007-08
and 2012-13, while the interest on balance with RBI and other interest
earned grew at a CAGR of 14.5 per cent and 16 per cent, respectively, for
the same period.
Private sector banks recorded a CAGR of 18.6 per cent between 2007-08
and 2012-13, driven by a 18.8 per cent growth in interest on advances and
18.7 per cent growth in income on investments.
Other interest earned registered a CAGR of 39 per cent, while interest on
balance with the RBI declined at a CAGR of 1 per cent during the same
period.
Foreign banks
Foreign banks registered the lowest growth in total interest income at a
CAGR of 11.6 per cent between 2007-08 and 2012-13.
However, income on investments grew the most among all bank groups at a
19.9 per cent CAGR.
Interest on balances with the RBI declined at a CAGR of 3.6 per cent, while
other interest income fell at a CAGR of 19.2 per cent.
Interest expended grew the most for nationalised banks
SCBs
The total interest expended by SCBs increased at a CAGR of 20 per cent
between 2007-08 and 2012-13.
For the same period, interest on deposits and interest on RBI and inter-bank
borrowings grew at a CAGR of 20.5 per cent and 18.8 per cent, respectively.
In 2012-13, interest expended by all banks grew by 20 per cent y-o-
y, a slower growth as compared to 44 per cent growth in 2011-12.
However, the growth was higher than that of interest earned
during the year (17 per cent), thereby exerting a downward
pressure on the growth in both, operating and net profits of the
banks.
Interest expended grew the most for nationalised banks
SCBs
SBI and associates
Between 2007-08 and 2012-13, the total interest expended by SBI and its
associates rose at a CAGR of 17.4 per cent.
The interest on deposits and interest on RBI and inter-bank borrowings
grew at a CAGR of 18.3 per cent and 7.6 per cent, respectively, while other
interest expenses grew a higher CAGR of 13.5 per cent for the same period.
Nationalised banks
From 2007-08 to 2012-13, the total interest expended by nationalised banks
registered the highest growth at a CAGR of 22.7 per cent.
Interest on deposits grew at CAGR of 23.4 per cent, while, interest on RBI
and inter-bank borrowings and other interest expenses went up by 29 per
cent and 11.3 per cent, respectively, during the same period.
The total interest expended by private sector banks increased at a CAGR of
17.2 per cent between 2007-08 and 2012-13.
Both, interest on deposits and interest on RBI and inter bank borrowings
grew at healthy CAGR of 16.8 per cent and 27.1 per cent, respectively,
while the other interest expenses registered a growth of 13.7 per cent
during the same period.
Foreign banks
From 2007-08 to 2012-13, foreign banks posted a CAGR of 12.1 per cent in
total interest expended, the lowest amongst all bank groups.
Over the same period, interest on deposits and borrowings rose at a CAGR
of 12.8 per cent and 7.9 per cent, respectively, while other interest expense
recorded a CAGR of 16.8 per cent during the same period.
In general, domestic banks mobilise deposits to meet funding
requirements, while foreign banks (on account of their restricted
branch network) have a higher proportion of borrowed funds to
meet their funding requirement vis-? -vis their domestic peers.
The share of interest on borrowed funds in total interest expended
for foreign banks is the highest among all bank groups at 20 per
cent.
Foreign banks
other income
Focus on core fee income essential to enhance profitability
Core fee income is generated from deposits, advances and other
normal banking services such as credit cards, depository
services and third-party distribution.
On the other hand, profit on sale of investments and fixed assets
and other sundry income are a part of miscellaneous income.
Since these are not regular sources of income, banks need to
concentrate on core fee income to enhance profitability.
Besides interest income, banks also earn fees (commissions or
brokerage income) for issuing letters of credit, providing
guarantees, bill collection and cash management services.
These sources of income together constitute a bank's other
income.
Income earned by way of profits on the sale of investments also
falls under this category.
However, for this chapter, we have excluded profits earned on the
sale of investments.
Focus on core fee income essential to enhance profitability
Other income's share fell along with drop in core fee income's share
For all scheduled commercial banks (SCBs), the share of other
income in the total income declined to 10.1 per cent in 2012-13
from 11.2 per cent in 2011-12 due to slower growth in
commission and foreign exchange income in 2012-13 in
comparison with 2011-12.
Core fee income (as a percentage of other income) also declined
to 80.1 per cent from 87.4 per cent over the same period.
Other income (ex-profit on sale of investments) as a percentage
of total income
In line with past trends, foreign banks had the highest proportion
of other income in total income.
The share of core fee income in other income also exceeded that of
all other bank groups.
A global presence has enabled foreign banks to dominate the
market for forex and trade finance transactions.
Syndication/ processing fees earned on foreign currency loans also
helps foreign banks boost their core fee income.
On the other hand, the share of other income in total income has
traditionally remained low for nationalised banks, as their foray
into peripheral product segments has been quite slow.
Other income (ex-profit on sale of investments) as a percentage
of total income
Core fee income as a percentage of other income
In absolute terms too, SCBs' core fee income increased at a CAGR of 12
per cent over 2007-08 to 2012-13, mainly driven by growth in
nationalised banks and private sector banks.
Core fee income
All bank groups recorded a rise in profit on sale of investments in 2012-13
Profit on sale of investment
In 2012-13, all the bank groups witnessed a rise in profit on sale of
investments. Also, as a percentage of total income, the profit on
sale of investments increased to 1.2 per cent in 2012-13 as against
0.5 per cent in 2011-12.
SBI and its associates posted a loss of Rs 4.8 billion on the sale of
investments in 2011-12.
All bank groups recorded a rise in profit on sale of investments in
2012-13
Profit on sale of investment
Share of profit on sale of investments in total income
spreads
Spreads of SCBs declined by 17 bps y-o-y in 2012-13
Spread is the difference between the yield on carry business (advances
given by banks and investments) and the interest cost of banks (cost of
deposit and cost of borrowings).
In 2012-13, the spreads of scheduled commercial banks (SCBs) declined
to 2.35 per cent from 2.52 per cent in 2011-12.
Spreads of SCBs
While the cost of funds remained stable for banks in 2012-13, the
spreads narrowed due to a decline in the return on funds.
Interest earnings for banks were severely affected during the period
owing to a sluggish credit growth.
Spreads of SCBs
A study of group-wise spreads, i.e. SBI and associates, nationalised,
private, and foreign banks, indicates that foreign banks enjoyed the
widest spreads at 4.7 per cent in 2012-13.
Private sector banks' spreads were 3.56 per cent during the year,
followed by public sector banks, where State Bank of India (SBI)
and its associates, and nationalised banks, had spreads of 2.95 per
cent and 2.40 per cent, respectively.
SBI and associates
Spreads - SBI and associates
Spreads
The spreads of SBI and associates declined by 32 bps to 2.95 per
cent in 2012-13.
The yield on carry business declined marginally to 9.16 per cent
during the year while the interest cost rose by 29 bps y-o-y to 6.21
per cent, which resulted in the decline in spreads in 2012-13.
Yield on carry business
The yield on carry business declined marginally by 3 bps to 9.16
per cent in 2012-13, mainly due to a similar increase in interest
earned during the period and average funds deployed (advances
and investments).
The yield on advances declined by 36 bps y-o-y to 9.9 per cent,
while the yield on investments increased by 29 bps y-o-y to 8.08
per cent during the year.
Interest cost
In 2012-13, the interest cost increased by 29 bps to 6.21 per cent
whereas the cost of deposits rose by 40 bps to 6.37 per cent.
The cost of borrowings was lower by 74 bps to 5.69 per cent.
Banks typically resort to borrowings to meet mismatches in short-
term liquidity.
These form a very small portion of liabilities .
Hence, decline in the cost of borrowings has a marginal impact on
the interest cost.
Nationalised banks
Spreads - Nationalised banks
Spreads
The spreads of nationalised banks fell by 17 bps y-o-y to 2.40 per
cent in 2012-13.
The decline in spreads was mainly due to an increase in interest
cost and a decline in yield on carry business.
The yield on carry business remained almost similar at 9.09 per
cent in 2012-13, mainly due to a similar increase in interest earned
during the period and average funds deployed.
Interest cost
The interest cost for nationalised banks increased to 6.69 per cent
in 2012-13 from 6.56 per cent in 2011-12 on account of a rise in
the cost of deposits over the same period.
Spreads - Private sector banks
Spreads
The spreads for private sector banks increased by a marginal 8 bps
y-o-y to 3.56 per cent in 2012-13.
Unlike other banks, private banks witnessed an improvement in
spreads largely due to a faster increase in interest earnings as
against interest expended by this bank group during the period.
The yield on carry business for private sector banks increased by
32 bps y-o-y to 10.34 per cent in 2012-13 on account of a higher
increase in interest earned as against increase in average funds
deployed in carry business.
During the year, the yield on advances rose by 53 bps y-o-y to
11.52 per cent, while the yield on investments increased by 2 bps
to 7.28 per cent.
Interest cost
The group's interest cost also rose by 24 bps y-o-y to 6.78 per cent
in 2012-13 due to a 29 bps rise in the cost of deposits to 6.72 per
cent.
Many private sector banks, especially the old private sector
banks, offer higher interest on term deposits as compared to
public sector banks (nationalised banks and SBI and associates).
Private sector banks do not have a wide network of branches,
which is essential for garnering low-cost deposit volumes.
Foreign banks
Spreads - Foreign banks
Spreads
In 2012-13, the spreads of foreign banks declined by 41 bps y-o-y,
and, at the same time, had the highest spreads of 4.70 per cent
amongst all bank groups during the year.
The yield on carry business of foreign banks declined by 8 bps to
9.14 per cent in 2012-13.
The yield on advances declined by 5 bps y-o-y to 9.55 per cent
during the year while the yield on investments increased by 3 bps
to 8.13 per cent.
Interest cost
The interest cost of foreign banks increased by 33 bps y-o-y to
around 4.44 per cent in 2012-13.
This was driven by a 33 bps rise in the cost of deposits y-o-y to
4.67 per cent, coupled with an increase in the cost of borrowings
by 33 bps to 4.06 per cent.
During the year, the share of low-cost deposits in total deposits
of foreign banks stood at 41 per cent.
Within low-cost deposits, demand deposits had a higher share at
63 per cent as foreign banks generally prefer to cater to corporate
clients who maintain current account deposits, and also because
they have strong cash management systems.
Application of banking licences
Following are the list of aspirants who had initially applied
for banking license.
Table 1: List of entities in fray for banking license
Table 1: List of entities in fray for banking license
Banking license update
The Reserve Bank of India (RBI) in its notification on September 6,
2013, communicated two changes in the names of applicants for
new bank licenses in the private sector.
Following are the modifications:
1. Value Industries Limited has withdrawn its application
2. K.C. Land and Finance Ltd is included in the list
Further, Tata Sons Limited too has withdrawn its application on
November 27, 2013.
ARC-Summary
CRISIL Research expects the credit growth to increase to about 20
per cent during 2010-11 due to high capacity utilisation levels
necessitating capital investments, and increase in infrastructure
credit disbursements for projects wherein sanctions are already in
place.
We expect the deposit growth to range between 16 to 18 per cent in
order to support the credit growth.
Also, with respect to asset quality, Indian banks are likely to
deteriorate over the next 2 years and consequently, the gross non-
performing assets (NPAs) are expected to reach Rs 1,590 billion by
March 2012.
This increase in quantum of NPAs in the system would in turn, pave
way for augmented business opportunities for Asset reconstruction
companies (ARCs).
The asset reconstruction market has been in a state of comatose
for the last 2 years due to mismatch of price expectations
between the two parties involved the bank selling non-
performing assets and the asset reconstruction company
buying these assets.
We expect this issue to be resolved as the market matures,
going forward, with banks increasingly preferring to take
NPAs off their books.
Book value of assets acquired by ARCs to reach Rs 822 billion
by June 2012
The ARCs recorded a significant drop in asset growth to 24 per cent in
2008-09 from 45 per cent in 2007-08; they further declined to an
estimated 13 per cent in 2009-10.
Disagreement between ARCs and banks on pricing of assets and the
one-time restructuring facility provided by the RBI to banks was the
primary reason for the decline.
In fact, many auctions were called off in the last 2 years owing to price
mismatch between ARCs and the selling banks.
We expect these issues to be resolved and the total cumulative assets
acquired by ARCs to reach Rs 822 billion by June 2012 translating into a
CAGR of 19 per cent by 2011-12.
The following factors are expected to drive the growth:
1. Increase in quantum of NPAs
2. Increase in provisioning requirements
3. ARCs venturing into acquisition of retail assets
Book value of assets acquired by ARCs to reach Rs 822 billion
by June 2012
Share of cash deals to go up
The proportion of cash deals is expected to increase, as banks
increasingly prefer to completely remove the nonperforming
assets from their books.
Moreover, cash deals benefit banks, as cash is immediately
booked as an asset in their books, which can be utilised, and also
any excess provisions made for the NPAs are released back into
the system.
Asset sale to predominantly remain as resolution strategy
The sale of assets or business is observed to be the most
preferred resolution strategy adopted by ARCs.
The increased land costs and real estate prices have benefitted
ARC players in the past with respect to asset sales.
CRISIL Research expects, going ahead, asset sale to continue to
be the predominant resolution strategy.
However, the proportion of restructuring of assets and
settlement with promoters as a resolution strategy is also
expected to increase.
ARCs attain limited success in resolution
Owing to the nascent stage of the industry and the inherent
risks associated with the recovery of NPAs, ARCs have not
achieved any exceptional success in resolution of assets till date.
The ratio of security receipts (SR) redeemed to security receipts
issued has been low, though improving at a slow pace.
Only 21.8 per cent SRs, of the total issued, were redeemed at the
end of June 2009 as against 12.2 per cent at the end of June 2008.
Acquisition price and effectiveness of resolution strategy to
determine returns
The acquisition price, recovery amount and recovery period of
the asset are key parameters determining the returns of ARCs.
Insufficient information sharing by banks and improper
resolution strategy influence the acquisition price and the
recovery of asset.
Ability to aggregate debt and resolve bad debts through
effective resolution strategy would boost returns of the ARC
business.
ARC-current scenario
Introduction
An Asset Reconstruction Company (ARC) is set up for taking
over distressed assets/non-performing assets from banks or
financial institutions and subsequently, profiting from their
restructuring or sale.
Business model
Assets are acquired from the selling banks either through
auctions or through bilateral negotiations.
Typically, these assets are acquired at a discount to book value
ranging from 70 to 75 per cent.
In case of auctions, the asset is put to sale post an adequate and
diligent valuation and the interested parties submit their bids.
Most of the asset reconstruction companies rely on in house teams
for valuation of the distressed assets put up for sale by the selling
bank.
ARCs, normally, get 1 week to 30 days of time for examining the
auction documents and deriving their estimation on true value of
the asset.
Participating companies subsequently, propose their individual
bids.
Assets are acquired under a trust structure from selling banks via
two modes:
1. Cash deals
2. Security receipts (SRs)
Business model
Cash deals: This mode calls for a cash settlement with the
selling bank. NPAs are taken off the banks books and an instant
increase in cash attained by unlocking value from those NPAs
follows, which is a positive outcome for banks.
However, banks may have to take a significant hit on their
books, as NPA deals occur at a significant discount to original
book value of the asset.
Business model
Transaction structure- cash deal
Issue of security receipts: In this mode, funds for financing acquisition of NPAs
are raised by issue of SRs, in the form of pass through certificates, evidencing an
undivided right, title or interest in the underlying assets.
Transaction structure- issuance of SRs
Upon acquisition, NPAs are transferred to a trust, which
consecutively issues SRs to interested investors.
Security receipts equivalent to acquisition price are issued to
qualified institutional buyers (QIBs).
When banks/FIs sell their NPAs in return for SRs, it shows as an
investment in their books in proportion to their participation in the
security receipts issue.
These SRs are redeemed after the resolution of the stressed asset.
Typically, any upside received post resolution beyond a pre-
decided hurdle rate is shared with the participating SR investors in
the ratio of 80: 20 (80 per cent of the upside with the investors,
while the ARC retains 20 per cent).
The transaction structure for any acquisition deal, whether cash
or security receipts, is finalised only after negotiation with
lenders.
In cases where the seller is interested in having a stake in the
underlying asset, the seller may prefer the issue of SRs whereas a
cash deal may be preferred if the seller desires a clean exit.
ARCs' mode of transactions
Current market trends and market size
Sharp slowdown in asset growth in 2008-09 and 2009-10
Growth in the asset book of ARCs depends upon credit growth
in the market, increase in quantum of NPAs, and the ability of
ARCs to negotiate an acquisition price with the seller.
ARCs acquired assets of book value aggregating to Rs 414.1
billion registering a growth of 45 per cent y-o-y by end of June
2008.
However, as of June 2009, ARCs registered annual growth of
assets acquired at only 24 per cent to Rs 515.4 billion, indicating
a sharp slowdown in asset growth in 2008-09.
Based on our discussions with industry sources, we believe the
pace of growth in the asset book has slowed down further to 13
Details of asset book of ARCs
Slowdown in the ARC business can be attributed to the
following:
1. One-time restructuring allowed by the RBI to banks
encouraging them to restructure the doubtful assets instead
of recognising them as NPAs
2. Lack of convergence of price quoted by the ARCs and the
expectations of selling banks, leading to cancellation of many
auctions
Details of asset book of ARCs
Slowdown in asset growth
Slowdown in asset growth
ARCs have not achieved any phenomenal success as yet in resolution of
assets.
Security receipts redeemed as a percentage of security receipts subscribed
were only 21.8 per cent at the end of June 2009 against 12.2 per cent y-o-y.
Value of SRs redeemed on June 30, 2009 was at Rs 28 billion.
Further, the ratio of SRs redeemed to the book value of the assets acquired
was only 5 per cent as on June 30, 2009 against 2 per cent of June 30, 2007.
The limited success of ARCs in resolution can be attributed to the industry
still being in the nascent stage and inherent risks associated with the
recovery of NPLs.
However, it is too early to draw conclusions on the ability of ARCs to
achieve successful resolution.
Cash deals versus security receipts
As mentioned earlier, ARCs acquire NPAs either through cash deals
or through security receipts.
All cash deals, of ARCs total deals, were in the range of 15 to 20 per
cent in the year ended 2009.
Total value of SRs issued by ARCs was Rs 128 billion as of end-June
2009.
Banks take a major chunk of these subscriptions.
Banks sell their distressed assets to ARCs and subsequently,
subscribe to the SRs issued by ARCs.
In this manner, banks can change their role from being a lender to
being an investor.
Banks benefit by staying invested in SRs and sharing any upside
in recoveries by the ARCs upon resolution.
The FII investment in SRs has been limited owing to the
regulatory cap of up to 49 per cent and 10 per cent cap for
collective and single FIIS, respectively.
Cash deals versus security receipts
SR subscriptions - 2009
Extremely competitive ARC market
There are 13 players in the ARC space.
Several new players have entered the asset reconstruction
business especially since 2006-07, reflecting the growth potential
and increasing competition.
ARCs operating in India
Asset Reconstruction Company India Ltd (ARCIL), the leading
collector of distressed assets, dominates the ARC space.
Its market share was close to 95 per cent in 2005-06, which came
down to 40 per cent (on incremental asset acquisition basis) in
2009-10.
Competition in the business became more intense on account of
the following:
1. Low entry barriers: A player foraying into the asset
reconstruction business requires fulfilling minimum criteria of
capital adequacy requirement of 15 per cent or Rs 1 billion
whichever is less.
This minimises entry barriers for new players and in turn
encourages competition in the asset reconstruction business.
2. Expectations of rise in NPAs: Asset growth for ARCs is linked
to credit growth and NPAs.
The quantum of NPAs is expected to rise with the pickup in
systemic credit growth.
For example, gross NPAs increased to Rs 885 billion by end of
March 2010 from Rs 567 billion end of March 2008 recording a
CAGR of 25 per cent in the same period.
3. Strategic fit: Majority of ARC players have other business
interests in financial services domain.
Hence, the ARC business is perceived as a strategic fit for such
entities.
Classification of assets acquired by ARCs
Bank category-wise asset acquisition
Bank category-wise NPAs - 2008-09
Estimated bank category-wise acquisitions by ARCs, 2008-09
Despite the public sector banks holding a higher percentage of
NPAs (close to 66 per cent), their share to the asset
acquisitions of ARCs has been 49 per cent.
On the other hand, private sector banks holding 24 per cent of
NPAs have contributed as high as 48 per cent to the asset
acquisition by ARCs.
This is because private sector banks have been aggressively
involved in selling their NPAs to ARCs while the public sector
banks have preferred to retain such NPAs in their books for
longer time period.
Classification of assets acquired by ARCs
Asset category-wise acquisitions
Asset acquisition categories:
1. Corporate loans
2. SME loans
3. Retail loans
Corporate loans coupled with SME loans account for 90 per
cent of acquisitions in case of asset category-wise classification.
Percentage contribution - asset category-wise 2008-09
During auctions, a mix of large and small corporate assets is created to
form a portfolio of assets to promote competitive bidding by ARCs.
A typical mix of accounts in a portfolio is 2 to 3 large accounts and 15 to
20 small accounts.
While the resolution of a corporate loan portfolio provides lumpy cash
flows to the ARC, the retail portfolio provides relatively steady cash
flows.
ARCs have been reluctant to venture into retail portfolio due to the small
ticket size of retail loans that make it relatively unattractive for ARCs.
Moreover, the fragmented nature of retail loans demand strong network
presence from ARCs.
However, the situation is gradually changing and retail loans have
become acquisition targets for ARC players.
Percentage contribution - asset category-wise 2008-09
Sector-wise acquisitions
Textiles, iron and steel, power, metals and fertilisers are the
top five sectors that contributed largely to asset acquisitions
by ARCs.
These sectors recorded a higher percentage of restructuring
under the CDR mechanism at the end of June, 2010.
Of late, asset acquisitions have also taken place from the
home loan segment.
Sector-wise debt aggregations under the CDR mechanism:
CDR cases for top 5 sectors (as on June 30, 2010)
Sector-wise acquisitions
Geography-wise acquisitions
ARCs do not specifically prefer geographic areas for asset acquisition.
Following factors, however, do affect their geographical presence:
1. Law in a particular state: It influences the ARCs ability to recover funds
2. Level of industrialisation in the state: Assets from industrialised states
such as Maharashtra and Gujarat typically form a large proportion of
assets given their high level of industrial activity
3. Varying stamp duties in different states: In case of portfolio of assets,
differential stamp duties influence the choice of state
for registration of deals.
States like Madhya Pradesh and Tamil Nadu charge higher stamp duty
and registration fees, hence, ARCs avoid registering the asset portfolio
in these specific states.
Resolution strategy
The ARC implements the resolution strategy for the NPAs after
acquiring them from sellers.
The SARFAESI Act has empowered ARC to execute NPA resolution.
Key resolution strategies adopted by ARCs:
1. Sale of business or assets
2. Business and financial restructuring
3. Assignment of debt
4. Settlement of debt
It has been observed that sale of assets or business is the most
common route of resolution strategy.
Choice of resolution strategy is a function of asset. Asset under
resolution can be of the following types:
1. Large running unit (fully/partially operating)
2. Large closed down unit
3. Small account
The following figure depicts the various routes available for
asset resolution in conjunction with the resolution strategy:
Resolution strategy
Typical resolution strategy- asset wise
In case of large accounts, still in operation, selling off assets is
not a viable option owing to hurdles created by promoters and
employees of the unit who have their own respective interests.
Restructuring of business or settlement with promoters is a more
feasible option for such accounts.
In case of small assets, choice of resolution is relatively flexible,
as selling off the asset is comparatively easier.
Also, restructuring is another viable option.
Typical resolution strategy- asset wise
Evolution of ARCs
The foundation of recovery mechanism was laid in 1993.
Recoveries of Debts Due to the Banks and Financial Institutions
(RDDBFI) Act 1993:
The procedure for recovery of debts to the banks and financial
institutions resulted in significant portions of funds getting
locked.
The need for a speedy recovery mechanism for realising dues to
banks and financial institutions was felt.
Hence, the RDDBFI Act was passed in 1993 that instated Debt
Recovery Tribunals (DRTs) in the country.
In order to regulate and control the NPAs and quicken recovery,
the government of India set up Debt Recovery Tribunals and Debt
Appellate Tribunals under the RDDBFI Act.
Evolution of ARCs
It defined the scope and powers to be granted to these DRTs
and the conditions in which appeal can be made to these
authorities.
Corporate Debt Restructuring (CDR): The CDR mechanism,
which predominantly deals with restructuring of sub-standard
assets for large corporates, was incorporated in 2001.
A CDR system was established to ensure timely and transparent
restructuring of corporate debts of entities facing financial
difficulties.
In particular, the system aimed at restructuring of viable
corporate/businesses impacted by certain internal and external
factors, thus minimising losses to creditors and other
stakeholders.
Evolution of ARCs
Securitisation and Reconstruction of Financial Assets and
Enforcement of Security Interest Act (SARFAESI) 2002: The
SARFAESI Act was introduced in 2002.
This Act came up with the first set of guidelines providing a
structured framework with respect to ARC operations.
The Act was passed to legalise securitisation and reconstruction
of financial assets and enforcement of security interest.
It envisaged the formation of asset reconstruction companies
(ARCs)/Securitisation Companies (SCs).
It also allows ARCs to take over the management of the
borrowers business with a right to sell, assign, or lease the
secured assets, if substantial business of the borrower is held as
security for debt.
Evolution of ARCs
CDR versus ARCs: The gamut of options available to ARCs (under the
SARFAESI Act) is much wider compared to the CDR mechanism.
Under CDR mechanism, lenders address the financial structure of the
company by deferring the loan repayment and aligning interest rate
payments to suit companys cash flows.
Thus, the CDR mechanism predominantly focuses on the financial
restructuring of corporate assets.
SARFAESI Act, on the other hand, essentially provided the platform for the
formation of ARCs in India.
The act empowers secured creditors to enforce security interests without the
intervention of a court or tribunal.
It also allows ARCs to take over the management of the borrowers business
with a right to sell, assign, or lease the secured assets, if substantial business
of the borrower is held as security for debt.
Evolution of ARCs
Regulations
Key regulations governing operations of ARCs
1. Every ARC should obtain a certificate of registration (COR) from
the regulator to undertake both securitisation and reconstruction
activities.
2. Every ARC should have a minimum owned fund requirement of
Rs 2 crore.
3. Minimum capital adequacy to be maintained by the ARC should
be 15 per cent of the total risk weighted assets or Rs 1 billion
whichever is less.
4. In this backdrop, almost all new ARCs commence operations with
initial capital base of Rs 1 billion.
5. This floor was set with the aim of creating entry barriers in ARC
space owing to inherent risks of the business.
6. ARCs are allowed to acquire assets in their own books or directly in
the books of the trusts set up by them.
7. An ARC can undertake only securitisation and asset reconstruction
activities.
8. Assets acquired by securitisation company or reconstruction
company (SC/RC) should be transferred to the trusts set up by the
SC/RC at the price acquired from the originator of the asset.
9. Assets acquired by the SC/RC are required to be resolved within 5
years from the date of acquisition of such assets.
10. However, if the assets remain unresolved at the end of 5 years, then
the period of realisation may be increased to 8 years from the original
date of acquisition.
Regulations
11. Every SC/RC should issue security receipts (SRs) through the trust
and such security receipts should be issued only to QIBs.
12. FIIs have been permitted to collectively invest up to 49 per cent in
SRs issued by ARCs subject to condition that the investment by a
single FII should not exceed 10 per cent of the issue.
13. Every SC/RC is required to declare Net asset value (NAV) of the
security receipts issued semi-annually.
14. For NAV calculations SRs are required to be rated on recovery
rating scale and the rating agencies must be deployed to disclose the
rating rationale.
15. Assets acquired by the SC/RC for the purpose of asset
reconstruction should be treated as standard assets during the
planning period; typically 12 months.
Regulations
16. An SC/RC should deploy any surplus funds only in
Government securities and deposits with scheduled
commercial banks, Small Industries Development Bank of
India, National Bank for Agricultural and Rural Development
or any other entity specified by the Regulator.
Regulations
ARC outlook
Book value of assets acquired to reach Rs 822 billion by 2012
CRISIL Research expects total assets acquired by ARCs (in
terms of book value) to reach Rs 822 billion by June 2012,
implying a CAGR of 19 per cent.
With the market maturing and banks getting keener to remove
nonperforming assets (NPAs) from their books, we expect
factors such as price mismatch, which has stifled market
growth, to correct over the medium term.
Trend in asset acquisition and the movement in growth rate
Other market trends
Corporate loan to fuel asset acquisition growth
Although the proportion of retail assets in the asset book of asset
reconstruction companies (ARCs) is expected to increase, corporate
loans would continue to dominate the book (in terms of percentage
share) due to the larger ticket size of corporate loans and
complexities involved in resolution of retail assets.
Share of cash deals to go up
The proportion of cash deals is expected to increase, as banks
increasingly prefer to completely eliminate bad assets out of their
books.
Moreover, cash deals are beneficial to banks, as cash is immediately
booked as an asset in their books, which can be utilised and also any
excess provisions made for NPAs are released back into the system.
Asset sale remains the predominant resolution strategy
Going forward, CRISIL Research expects the asset sale to remain the
main resolution strategy for ARCs.
In the past as well, increased land costs and high real estate prices
have benefitted ARC players with respect to asset sale.
However, the proportion of restructuring of assets and settlement
with promoters as the resolution strategy could increase.
Growth drivers
Bulk increase in NPAs to provide better business prospects
The Indian banking sector reported NPAs of 2.3 per cent of gross
advances as on March 31, 2009 and 2.5 per cent by end of March 31,
2010.
CRISIL Research believes that the asset quality of Indian banks is likely
to deteriorate over the next 2 years primarily due to the following:
1. A few restructured assets turning bad
2. Continued stress in certain export-oriented sectors
Accordingly, we expect the gross NPA ratio to increase to 3.0
per cent by 2011-12 and the quantum of gross NPAs to reach Rs
1,590 billion by March 2012.
Growth drivers
Bulk increase in NPAs to provide better business prospects
Movement in gross NPAs of banking system
Incremental assets acquired as percentage of total NPAs
in ARC business
Higher provisioning requirements for banks to add to the ARC
asset base
The accelerated provisioning norms for banks are likely to result
in an increased flow of NPAs in the market.
The RBI recommended banks to provide 100 per cent provision
in respect of doubtful assets over 3 years old in 2006-07.
The RBI increased total provision coverage ratio to 70 per cent
for banks in 2009-10.
Tough provisioning requirement will result in banks selling
their NPAs to ARCs in order to reduce pressure on their profit
and loss.
Foray into retail portfolio to enhance asset base
With ARCIL foraying into retail loan segment, other ARC
players are expected to follow suit though gradually.
ARCs had always stayed away from retail assets leaving the
segment untapped largely on account of the following:
1. Small size and fragmented nature of retail loans make it
difficult for ARCs to value such assets
2. ARCs lack the huge network presence a prerequisite of retail
portfolio
However, retail loans would eventually start contributing to
the asset base of the ARCs given the increasing competition on
retail side.
Challenges to growth
The ARC business continues to face challenges, which hinder its
growth.
Lack of price convergence between ARCs and selling banks
Many auctions were called off during the last couple of years due to
mismatch of price expectations between banks and the ARCs, with
banks demanding a higher price than the price quoted by ARCs.
Moreover, at times, the price expectation of the selling banks was
higher than the best bid price offered in the auction.
Lack of adequate information input
ARCs believe that often banks do not share all the information
required to value the assets being sold to ARCs.
Also, banks at times do not disclose the reserve price, which makes it
difficult for the ARC to value the asset.
Risks and key success factors affecting the business
The acquisition price, recovery amount and recovery period of the
asset are key parameters determining returns and success of ARCs.
Risk factors such as legal disputes, insufficient information and
improper resolution strategy can influence the acquisition price and
recovery from the asset.
The ARCs ability to aggregate debt and quickly resolve bad debts
would boost the returns.
Risks
Given the risks associated with ARC business, every case calls for
detailed inspection and utmost care in choosing the resolution
strategy in order to maximise returns.
Risks associated with the ARC business:
Litigation risk
The litigation risk arises from pending outcomes on legal disputes and
allocation of cash flows among secured lenders towards priority dues.
The litigation risk could lead to delays in resolution process.
The Government of India has been proactive in mitigating such
challenges and creating conducive environment for resolution of NPAs by
setting up of DRTs under the RDDBFI Act, introducing the corporate debt
restructuring mechanism and passing of the SARFAESI Act.
Lack of information
Insufficient information at the time of auctions leads to wrong valuation
of assets, which could affect the returns.
Risks
Improper selection of resolution strategies
Owing to an incorrect assessment of the impact of resolution
strategies, an inappropriate strategy may be chosen, severely
affecting the extent and timing of recoveries.
ARCs have used the SARFAESI Act as an effective tool to initiate
a dialogue with borrowers so as to overcome the above risk.
Management risk
The ARC management should be capable of implementing the
identified resolution strategies and consequently, maximising
recoveries from the NPA portfolio, within the prevailing legal
and regulatory framework.
Key success factors
Decisions related to asset acquisition
These include selecting the exact asset for acquisition and
quoting the accurate price for it.
It becomes essential to rightly value large assets in the portfolio
and arrive at fair estimates for the remaining assets, which
would ensure correct valuation of assets acquired by ARCs.
Ability to rapidly resolve bad debts
Taking the promoters into confidence is a critical aspect of asset
resolution.
Also, working efficiently with dealers (in case of retail loans)
and borrowers are important aspects, which help in asset
resolution at a greater pace.
Capability to aggregate debt
Key success factors
According to RBI regulations, at least 75 per cent (on value
basis) of the lenders of the asset must agree to the choice of
resolution strategy deployed by the ARC management
company, without which, the resolution will get delayed
unnecessarily.
As NPAs rapidly lose value, the capability to aggregate debt
faster is important for growth prospects of any ARC.
Illustrative IRR
We have attempted to calculate the internal rate of return (IRR)
for a hypothetical ARC portfolio for both the modes of payment
namely, issuance of security receipts and cash deals.
(A) Issuance of security receipts (SR)
Our assumptions are as follows:
1. Asset value: Rs 100 million
2. Asset management fees: 1.50 per cent
3. Discount rate: 30 per cent
4. Operating costs: 0.2 per cent of SR value
5. Recovery amount: Rs 20 million
Case 1: Resolution period - 6 years
Case 2: Resolution period - 9 years
(B) Cash deals
Cash deals
Basel 3-summary
Equity capital raising difficult for public sector banks, increased
dependence on government
CRISIL Research has estimated that Indian banks will need to raise around
Rs 2.9-3.2 trillion in the form of Tier 1 capital over the next 6 years in order
to comply with the stringent capital adequacy norms proposed by the
Reserve Bank of India (RBI) to meet the Basel III guidelines - the global
regulatory framework for banks.
CRISIL Research estimates that more than 90 per cent of the additional Tier
1 capital required over the next 6 years needs to be raised by public sector
banks (PSBs).
We believe that raising such a huge amount of capital would be a challenge
for the PSBs, who have together raised only Rs 0.5 trillion of equity capital in
the last 7 years up to March 2011.
We, therefore, believe that the stipulated norms can be met only with the
support of the Government of India (GoI) through capital infusion.
Basel III capital adequacy norms to pull down banks' RoE
PSBs in India will have to raise significant Tier 1 capital,
predominantly in the form of equity, between 2013 and 2018.
The resultant increase in their equity capital requirement is
expected to pull down their return on equity (RoE) by 300-400
basis points over March 2011 levels.
Indian banks will not face difficulty complying with leverage norms
Based on the comfortable leverage ratio currently enjoyed by
these banks and the expected equity infusion, we believe that
Indian banks are comfortably placed to meet the leverage ratio
of 4.5 per cent proposed by the RBI.
Cost of non-core capital will rise
Non-common equity capital for Tier I purposes (preference
shares, bonds) will be loss-absorbing capital in the event of
insolvency, either by conversion to common shares or through a
write-down.
Though insolvency of a bank may be regarded as an event with
remote possibility, such instruments will become costlier and
their market size will be smaller.
Basel 3-salient features
Background
Basel III proposes many new capital, leverage, and liquidity
standards to strengthen regulation, supervision and risk
management of the banking sector.
The capital standards and new capital buffers under Basel III
will require banks to hold more capital and better quality of
capital than under current Basel II rules.
The new leverage ratio also introduces a non-risk based
measure to supplement the risk-based minimum capital
requirements.
One of the main reasons for the severity of the economic and
financial crisis of 2008 was that the banking sector in many
countries had built up excessive on and off-balance sheet
leverage.
This was accompanied by a gradual erosion of the level and quality of the
capital base.
At the same time, many banks were holding insufficient liquidity buffers.
The banking system, therefore, was not able to absorb the resulting
systemic trading and credit losses.
During the most severe period of the crisis, the market lost confidence in
the solvency and liquidity of many banking institutions.
The weaknesses in the banking sector were rapidly transmitted to the rest
of the financial system and the real economy, resulting in a massive
contraction of liquidity and credit availability.
Ultimately the public sector had to step in with unprecedented injections
of liquidity, capital support and guarantees, exposing taxpayers to large
losses.
Background
Guidelines aimed at making banks more resilient to economic stress
In order to comply with the Basel III guidelines, aimed at
strengthening the global banking sector in the aftermath of the
economic crisis of 2008-09, the Reserve Bank of India (RBI) recently
announced its final set of guidelines for Indian banks.
These guidelines are more stringent than the ones laid down in the
Basel III framework and lay down strict capital adequacy norms
that propose to enhance the quality of the banks' capital by
increasing the equity component therein.
Besides, these guidelines also propose to enhance the loss
absorption capacity of non-equity Tier 1 capital and subordinated
debt (instruments having lower charge on the banks' assets
compared with other debt instruments).
Moreover, Indian banks will have to reach the proposed capital
adequacy requirements in a phased manner by March 2018,
earlier than the 2019 timeframe laid down in the original Basel
III framework. (Please refer to Annexure 1 for a snapshot of the
transitional arrangements.)
Guidelines aimed at making banks more resilient to economic stress
Salient features of RBI guidelines on implementation of Basel
III regulations in India
The guidelines propose an enhancement in the minimum Tier 1
capital adequacy ratio to 7 per cent of a bank's risk weighted
assets (RWA), while retaining the total capital (including both
Tier 1 and Tier 2 capital) adequacy ratio at 9 per cent.
Moreover, RBI stipulates that the common equity Tier 1 capital
should be at least 5.5 per cent of its RWA, higher than the 4.5 per
cent laid down by the Basel Committee on Banking Supervision
(BCBS).
In addition, banks would be required to maintain a capital
conservation buffer (CCB) of 2.5 per cent, comprising only
common equity capital, to be dipped into in times of economic
stress.
With the stipulation of a CCB buffer, the total capital requirement
of banks has been raised to 11.5 per cent of their RWA (refer
annexure 4).
The guidelines also lay down a write-off clause according to which
non-equity capital instruments issued by Indian banks such as
perpetual non-cumulative preference shares (PNCPS), innovative
perpetual debt (IPD), and upper and lower Tier II bonds can be
written off or converted into common equity upon the occurrence
of the trigger event, called the 'Point of Non-Viability' (PONV)
Trigger.
This clause is intended to ensure that investors holding these
instruments are treated on par with equity shareholders in case the
viability of a bank is under threat.
Existing non-equity capital that no longer qualifies as
regulatory capital instruments due to the absence of a write-off
clause will have to be phased out over the next 10 years.
Deductions with respect to goodwill, intangibles, pension
liability gap are to be adjusted from the common equity capital
and not from the Tier 1 capital being followed currently.
All scheduled commercial banks (SCBs) will now have to
adhere to the leverage ratio requirement of 4.5 per cent.
Leverage ratio is the ratio of a bank's tier I capital to its on and
off balance sheet exposures.
Minimum Capital Requirements
Basel 3-current position-indian banks
Write-off clause to impact Indian banks
Public sector banks capital composition (March 2011)
Private sector banks capital composition (March 2011)
Inclusion of write-off clause could affect banks' prospects of
raising non-equity capital
The quantum of equity required to be raised to meet the capital
requirement would hinge critically upon the market appetite for non-
equity capital instruments such as subordinated debt, IPD (innovative
perpetual debt) and PNCPS (perpetual non cumulative preference
share).
We believe that the write-off clause would increase the risk perception
of these instruments and would, hence, affect the demand for them.
Moreover, the cost of the capital would also go up as the returns on
these instruments have to be commensurate with the enhanced risk.
Also, the price discovery may not be easy as it could be difficult to
assess the probability of conversion to equity or a principal write-down
and the extent of loss after the event.
Further, considering the riskier nature of these instruments, there
may be a lower credit rating of such instruments as compared to
existing capital instruments.
The major subscribers to these instruments are banks and under
Basel III there will be full deduction of capital on reciprocal cross
holdings* (refer to annexure 2) of banks.
However, there will be no deduction if banks are investing in other
banks' capital (if it is not cross holding) but the risk weights will be
higher (refer to annexure 3).
Given the full deduction of reciprocal cross holdings, higher cost
and risk associated with it, CRISIL Research believes the growth of
issuance of such instruments will come down substantially.
As of March 2011, nearly 35 per cent of the total capital of public
sector banks and 27 per cent of total capital of private banks is in
the form of non-equity instruments.
Non-equity capital (including innovative instruments) worth Rs
1613 billion and Rs 431 billion has to be phased out in the next 10
years for public sector banks and private sector banks
respectively.
Of this, 60 per cent will be needed to be phased out by March
2018.
However, private sector banks are relatively better placed given
that their CAR is at 16.5 per cent as compared to public sector
banks with a CAR of 13 per cent as of March 2011.
Public sector banks Tier I capital as of March 2011
Private sector banks Tier I capital as of March 2011
While most of the private sector banks have core capital in
excess of 8.5 per cent, that is not the case with some of the public
sector banks, as seen in the chart above.
Public sector banks in India will have to raise significant Tier 1
capital, predominantly in the form of equity , between 2013 and
2018 .
Private sector banks Tier I capital as of March 2011
Basel 3-Impact on Indian banks
Banks will need to raise an additional Rs 2.7 trillion of
Tier 1 capital over the next 5 years to meet the new norms
Indian banks have historically maintained capital adequacy
levels at 4-5 percentage points higher than the regulatory
requirement.
As of March 2011, the capital adequacy ratios of Indian banks
stood at 13.1 per cent and 16.5 per cent for PSBs and private
sector banks, respectively.
While Indian banks are comfortably placed to meet the proposed
capital adequacy norms in the near term, CRISIL Research
estimates that banks, especially PSBs, would be required to raise
huge capital by March 2017 to meet the suggested norms (and
have a small buffer over and above the regulatory requirement)
without compromising on growth.
Assuming a RWA growth of 17-18 per cent (CAGR) over the next
5 years, and an average capital adequacy of 12 per cent for PSBs
and 12.5 per cent for private sector banks by March 2017, we
expect an additional capital requirement of Rs 4.2 trillion over the
next 5 years.
Of this, the Tier 1 capital requirement would be Rs 2.7 trillion to
be raised through a mix of equity and non-equity instruments.
Banks will need to raise an additional Rs 2.7 trillion of
Tier 1 capital over the next 5 years to meet the new norms
Public sector banks will need to raise 90 per cent of the
additional capital; private sector banks comfortably placed
to meet norms
Of the Rs 2.7 trillion of additional Tier 1 capital required over the
next 5 years, more than 90 per cent will have to be raised by the
PSBs, given their dominant share in the Indian banking system
and their lower capital adequacy ratios as compared to their
private counterparts.
We believe that raising such a huge amount of capital would be
a challenge for the PSBs, who have together raised only Rs 0.5
trillion of equity capital in the last 7 years up to March 2011.
We, therefore, believe that the stipulated norms can be met only
with the support of the Government of India (GoI) through
capital infusion.
Equity capital raising difficult for PSBs, increased dependence
on government
Public sector banks fund raising
Government allocated Rs 600 bn in last five years
In the past seven years, public sector banks have raised most of
their capital requirement through the debt route.
Going forward, raising capital through the equity route will not
be an easy task given that most of the capital in the past has been
raised through the debt route as well as the fact that the return on
equity of PSBs is expected to fall in the coming years.
This will make the public sector banks highly reliant on
government funding.
Government allocated Rs 600 bn in last five years
Capital expansion to affect RoE of PSBs
CRISIL Research believes that the expansion of equity capital
needed to meet the new capital adequacy norms and the
expected increase in the cost of non-equity capital following the
inclusion of the write-off clause would affect the returns
generated by PSBs over the longer term.
As a major portion of the additional Tier-I capital will be raised
by public sector banks in the form of equity, their average
return on equity (RoE) is expected to fall by 300-400 bps, from
around 16.4 per cent in 2010-11 to 12.5 per cent by 2016-17.
Indian banks well placed to meet leverage requirements
The objective of the leverage ratio is to check the banks' off-
balance sheet and the on-balance sheet leverage while
complementing the existing capital adequacy norms.
Although the Tier 1 leverage ratio requirement of 5 per cent is
more stringent than the 3 per cent stipulated by the BCBS, we
believe that adherence to this norm will not be difficult as this
ratio for the Indian banking system already stands at 6 per cent
(as of March 2011).
Moreover, the expected increase in the equity component of the
capital will enable Indian banks to conform to the specified
leverage requirement.
advances
Credit growth slows down in January 2014
Credit growth in the banking sector, which grew by 17-18 per cent
(y-o-y) during August - October 2013, moderated significantly in the
December 2013 - January 2014 period to 14-15 per cent due to the
economic slowdown.
The credit outstanding of scheduled commercial banks had grown
by 14.7 per cent y-o-y as on January 24, 2014.
System-wide loan growth moderated back to the pre-July levels of
~14 per cent y-o-y.
The credit growth remains sluggish with meagre demand for long-
term funds from companies.
With rates easing on the back of a cut in the Marginal Standing
Facility (MSF) rate, commercial paper (CP) and certificate of
deposits (CD) rates have also softened, pushing demand for
short-term funds back into the money market from banks.
We believe that lower bond yields have resulted in continued
migration of credit demand to credit substitutes.
Credit growth slows down in January 2014
Slowdown in investment cycle
New loan sanctions have also decreased significantly over the past
2 years with companies postponing capital expansion plans in the
wake of slower economic growth and declining returns on
investments.
RBI data shows that this trend is likely to continue even in 2013-14,
with almost 42 per cent decline in investments y-o-y.
Weak demand conditions, high inflation inhibiting reduction in
interest rates and policy hurdles are expected to restrict companies
from proceeding with their investment plans.
Phasing of capital expenditure of projects assisted by financial
institutions
Credit offtake to pick up in 2014-15
Credit growth projections
We expect bank credit growth in 2013-14 to touch decadal lows, as
GDP growth declines to 4.9 per cent (from an estimated 5.0 per cent
in 2012-13) and interest rates stay elevated.
Aggregate bank credit is forecast to grow by 14-15 per cent y-o-y on
account of lower investments and increased credit risk.
However, the growth is expected to be supported by the draw down
of sanctioned limits, growth in agriculture and retail portfolio and
refinancing of foreign debt with domestic debt.
In an unanticipated move, the Reserve Bank of India (RBI) in its
third-quarter review of the monetary policy hiked the repo rate to
8.0 per cent.
The RBI indicated that the move was necessary to bring down CPI
inflation to 8 per cent by January 2015, as recommended recently
by the Urjit Patel Committee.
RBI's emphasis on bringing down CPI inflation further to 6 per
cent over the next 24 months suggests limited downside to
interest rates in the coming months.
Moreover, banks are unlikely to increase their lending rates
immediately as their pricing power is weak in spite of high cost of
funds (reflected in deposit rates).
Sectoral credit growth
Credit growth has now settled at 14.8 per cent compared to ~18 per cent in
September 2013.
Personal loans and services sector were the primary drivers of this loan
growth.
Personal loans registered higher growth than the overall credit growth,
primarily driven by home loans and the 'other retail' segment.
In industry, growth was primarily driven by the infra sector due to
disbursals from earlier sanctions.
Loan growth would remain a challenge for Indian banks given that there are
no new sanctions for infra projects and growth is slowing in vehicle loans.
Moreover, with home loans being the only segment with reasonable growth,
we expect competitive intensity to intensify further in this segment.
Sectoral credit growth
Credit growth moderation expected in private and public
sector banks
Private banks typically grow at a faster pace than their public
sector counterparts owing to:
1. Better marketing focus in terms of products
2. Opening of larger number of branches as compared to public
sector banks
3. Base effect
Credit growth moderation expected in private and public sector
banks
occupation wise credit
Credit growth to revive in 2014-15 post elections
While overall credit growth should remain moderate (at 14-15 per
cent in 2013-14), we believe that the services and retail sectors will
be the biggest drivers of growth in loans disbursed.
Credit growth is expected to revive to 16-18 per cent in 2014-15,
especially in the second half, after the general elections (assuming
decisive mandate).
Expected growth in occupation-wise deployment of credit
As on January 10, 2014, the outstanding credit of scheduled commercial
banks had grown by 14.8 per cent (y-o-y) .
Credit growth remains sluggish with meagre demand for long-term
funds from companies.
While corporate capex is at an all-time low, we are still pegging loan
growth at around 14-15 per cent in 2013-14 because banks continue to
provide liquidity support to large corporate groups.
The sectoral deployment of credit reveals that most of the incremental
loan growth has been in the stressed sectors of power, roads and metals.
Healthy growth in housing (partially driven by LAP), auto loans and
growth in consumer durables will aid overall retail growth.
Growth in the CV portfolio is expected to be moderate on account of
challenges in terms of asset quality and cautious outlook.
Expected growth in occupation-wise deployment of credit
Industrial credit growth to recover moderately in 2014-15
Monthly disaggregated data published by the Central Statistical
Office indicates that industrial production growth has moderated
to -0.6 per cent y-o-y as of December 2013.
With contraction in manufacturing output, credit offtake slowed
across industries such as mining, textiles, petroleum,
pharmaceuticals, engineering and construction.
Overall bank credit to industry grew by 14.1 per cent y-o-y in
January 2014, lower than the level of 15.2 per cent recorded a year
ago.
IIP growth at lowest level in the last 5 years
India is likely to see a consumption-led GDP growth in 2013-14,
as investments remain slack.
Based on CRISIL Research's poll of 228 companies (which
account for around 62 per cent of market capitalisation of the
CNX Nifty 500), we expect a 14 per cent drop in capex in 2013-14.
The drop in capex is expected to be the second consecutive drop
in corporate investments.
IIP growth at lowest level in the last 5 years
Economic slowdown keeps corporate loan book growth at low levels
At the sectoral level, the fall is broad-based. Capex in the
infrastructure sector (which includes oil and gas, telecom, power,
roads, ports and airports) is expected to decline by 27 per cent
between 2012-13 and 2014-15 compared with the period between
2010-11 and 2012-13.
Investment in non-infrastructure sectors is expected to fall by 21 per
cent in the same period.
Economic slowdown keeps corporate loan book growth at low levels
Incremental share of infra loans vis- -vis incremental
corporate loan book is stabilising
Sugar, capital goods, textiles, automobiles (including auto ancillaries)
and infrastructure will bear the brunt.
Low profitability, highly leveraged balance sheets and unfavourable
policies in key markets will hamper investments of sugar companies.
Capital goods manufacturers too will defer their investments as long
as the slump in infrastructure investment continues.
Automobile and auto component manufacturers are also going slow
on production because demand growth in all segments, barring
tractors, is at decadal lows.
Industrial credit growth is expected to remain muted at about 14-15
per cent in 2013-14 (lower than the 17.4 per cent growth as of March
2013) as banks release already-sanctioned funds for projects.
Progress on the Land Acquisition Bill and the National
Investment Board would be critical in putting infrastructure
projects back on track.
There is no new capital expenditure (capex) as most companies
are waiting for the general elections so that the political
uncertainty abates.
Once a new government is elected at the Centre, there could be
some revival in capex. In the interim, there are expectations that
government / PSU company-driven investments could lead to
some capex in the public sector.
Growth in corporate loans is expected to increase to 17-18 per
cent in 2014-15 due to revival in industrial capex.
Credit growth in the services sector to remain strong in 2014-15
Credit growth in the services sector is driven by increase in trade
activity, commercial real estate development and non-banking
financial companies (NBFCs).
Credit growth in the sector slowed down to 17.4 per cent as of
December 2013, compared to 18-20 per cent levels seen between
August and November 2013.
The slower growth was due to slow growth in transport, shipping,
tourism and marked deceleration in NBFCs' credit offtake.
Of the above, credit growth in the transportation segment remained
slow, because of a slowdown in production of commercial vehicles.
Growth in services is largely led by trade (19.6 growth y-o-y) due to
higher inflation and the need for higher working capital.
Credit to the services sector is expected to go up by about 14 per cent
and 17 per cent in 2013-14 and 2014-15, respectively.
Growth in services is closely linked to growth in the industrial
segment, which is expected to be muted in 2013-14 and then pick up
in 2014-15.
Credit growth in the services sector to remain strong in 2014-15
Retail credit growth to improve in 2014-15
Growth in retail loans remained rangebound at 14-15 per cent in
2012-13, as interest rates and capital values remained high (in case
of the real estate sector) for most of the year.
As of December 2013, retail loans grew by 17 per cent y-o-y, aided
by a strong 15.8 per cent rise in housing loans.
As demand for corporate loans has moderated, banks have shifted
focus to retail loans which is driving this demand.
As the retail segment is expected to grow at 17 per cent and 19 per
cent in 2013-14 and 2014-15, respectively, faster than the overall
credit growth, its share in banking credit will rise from 18 per cent
in 2012-13 to 19 per cent in 2014-15.
components of credit
Share of long-term loans to decline, as companies curb investments
The share of long-term loans is expected to decline to 53 per cent by
2014-15 from 55 per cent in 2011-12.
The working capital cycle for companies is getting longer with the
increase in debtor and inventory days.
As a result, the share of short-term loans has been rising gradually
in the past 2-3 years amidst a slowdown in the investment cycle.
In 2013-14 and 2014-15, therefore, the share of working capital loans
(cash credit, overdraft and bills purchased and discounted) will
edge higher than that in 2012-13.
By contrast, growth in term loans is expected to moderate to 12.5
and 14.3 per cent in 2013-14 and 2014-15, respectively, from 17 per
cent in 2011-12, as corporate investments slow down.
Although new capital investments have dried up, the current
demand for term loans is arising from loans sanctioned
previously for ongoing projects.
As a result, working capital credit is expected to grow faster than
term loans in 2013-14.
Revenue growth forecasts, longer working capital cycles and the
willingness of banks to extend corporate credit are the key
factors that will influence growth.
Share of long-term loans to decline, as companies curb investments
Component-wise growth
deposits
Muted growth in deposits in 2013-14; marginal improvement
likely in 2014-15
Growth in deposits has tapered off from the high of ~17 per cent in
mid-December to ~15.5 per cent in January 2014.
Excluding the impact of FCNR (B) deposits (worth $26 billion and
raised under RBI's special scheme), at ~13.7 per cent, deposit
growth continues to lag credit growth of ~14.8 per cent.
Hence, without deposit growth picking up, loan growth for banks
would come at the expense of margins as they fund this growth by
raising money from wholesale markets.
Slower growth in demand deposits and savings bank deposits
mainly contributed to the overall slowdown of deposits (ex-FCNR).
We expect deposits to grow at 14-15 per cent in 2013-14 and
thereafter by 15-17 per cent in 2014-15.
Marginally higher growth in deposit mobilisation will be due to
economic revival in the second half of 2014-15.
Muted growth in deposits in 2013-14; marginal improvement
likely in 2014-15
FCNR (B) deposits have given some boost to growth in
deposits
Banks benefitted from NRI deposit inflows of almost $26 billion.
This is unlikely to recur but has helped bring down the average
Credit-Deposit (CD) ratio by increasing growth in deposits.
With loan growth likely to stay tepid in 2014, there is no upward
pressure on rates.
However, given the fact that the FCNR scheme has not been
extended beyond November 2013, we believe that deposit growth
would moderate back to 14-15 per cent y-o-y growth going
forward, resulting in reversal of the strain in CD ratio for banks to
their earlier levels.
In an effort to encourage banks to mobilise medium- to long-
duration liabilities from non-residents, the RBI announced
liberalised norms by way of:
deposits
1. raising the ceiling for pricing of FCNR (B) deposits (3-5 years
tenor);
2. exempting sticky, non-resident deposits from maintenance of
CRR/SLR balances;
3. excluding such deposits from balances calculated for priority
sector lending targets; and
4. introducing a swap window at 3.5 per cent per annum for
incremental FCNR (B) deposits mobilised for a minimum
tenor of 3 years up to November 30, 2013.
deposits
The primary feature of FCNR (B) deposits is that the currency risk is
borne by banks and not by depositors.
The principal as well as the interest on FCNR (B) deposits can be fully
repatriated and are not taxed in India.
Banks are allowed to lend up to Rs 10 million against FCNR (B)
deposits and have the flexibility to price such loans (against FCNRB
deposits) with reference to their respective base rates irrespective of
whether repayment is made in the home currency (rupee) or foreign
currency.
Banks mobilising FCNR (B) deposits were shying away from
converting foreign currency into the Indian rupee as they had to bear
the risk of currency depreciation, especially in view of the sharp
depreciation of the rupee against the US dollar since May 2013.
deposits
However, with the RBI offering banks a limited window period
to swap fresh FCNR (B) dollar funds (for a minimum tenor of 3
years) at a fixed rate of 3.5 per cent per annum, banks can lock
in their total cost of such deposits and re-invest in rupee loans
(given that such deposits no longer carry SLR and CRR
obligations).
deposits
Ex-FCNR deposit growth remains sluggish
Excluding the impact of FCNR (B) deposits (worth $26 billion
and raised under RBI's special scheme), deposit growth at ~13.7
per cent continues to lag credit growth of ~14.8%.
Companies are increasingly preferring to invest in money-
market instruments such as liquid mutual funds that offer
attractive returns over short maturities, instead of parking
money in current accounts of banks, which earn no returns.
Moreover, banks have started reducing the proportion of bulk
and wholesale deposits in the first half of 2013-14 as per
government directives, which has led to a muted growth in
deposits.
Mobilising deposits to remain a challenge for banks in 2014-15
With inflation forecast to remain elevated in 2013-14, deposit
mobilisation remaining tepid and borrowings costs increasing,
term deposit rates are expected to stay attractive in 2013-14 and
2014-15.
We project deposit growth to pick up marginally from 14-15 per
cent in 2013-14 (E) to 15-17 per cent in 2014-15 owing to the
following reasons:
1. Attractive deposit rates
2. Volatility in equity and debt markets
3. Volatility in gold prices
4. High capital values in urban and metro centres
While credit growth will be marginally higher at 16-18 per cent
as compared to the deposit growth, we expect credit-deposit (C-
D) ratio to reach around 80 per cent by March 2015.
In future, banks will have to check their C-D ratio, as resorting to
borrowings for lending will result in asset-liability mismatches
as well as higher costs.
Deposits are typically low-cost and stable sources of funding as
compared to borrowings.
Mobilising deposits has remained a challenge over the past 2-3
years as the household savings rate has fallen at a rapid pace,
due to rising inflation.
With no respite from the rise in inflation, garnering deposits will
still remain a challenge for banks .
Mobilising deposits to remain a challenge for banks in 2014-15
Trend in deposit growth
C-D ratio
CASA deposits decline
With companies opting to put money in more attractive market
instruments, the share of current account deposits in banks' total
deposits has begun to shrink.
Moreover, transactions in current accounts have reduced due to the
lacklustre performance of equity markets (Current account funds are
primarily used for settlement purposes in capital market
transactions).
The CASA ratio is estimated to slip marginally to 33.1 per cent by the
end of March 2015 from 33.3 per cent as of March 2013.
The story holds true even in the case of savings account deposits.
With advancements in technology, customers have been increasingly
transferring their savings account balances beyond a pre-specified level to
term deposits to earn higher interest income (Interest rates on fixed
deposits are 3-5 per cent higher as compared to those earned on savings
account deposits).
Term deposits recorded strong growth in 2012-13, mainly on account of the
rising opportunity cost of holding cash or demand deposits, as the interest
rates on term deposits were higher.
While government directives have played their part, the finance ministry
has also come out with a directive for public sector banks to reduce their
dependence on bulk deposits by capping the proportion at 15 per cent.
In order to substitute for these deposits, banks will have to keep interest
rates on retail deposits attractive.
CASA deposits decline
Share of CASA deposits
Asset Quality-GNPA
Asset quality to deteriorate further in 2013-14
Gross non-performing assets (GNPAs) deteriorated to 4.0 per
cent in December 2013 from 3.3 per cent in March 2013.
GNPAs are likely to stay at high levels in 2014-15 too as
corporate cashflows continue to remain strained.
Hence, CRISIL Research expects banks GNPAs to be at 4.0-4.2
per cent till March 2015 due to slippages from loans restructured
in 2012-13, continued stress in the infrastructure sector
(especially power) and construction segment, and lower asset
sales to Asset Reconstruction Companies (ARCs) owing to
pricing issues.
Asset quality at weakest level for public sector banks
Public sector banks (PSBs) reported higher GNPAs than those of
private banks in the first 9 months of 2013-14.
The number rose to 4.6 per cent as of December 2013 from 3.6 per
cent as of March 2013.
Such a marked deterioration in the asset quality of PSBs can be
attributed to the weak macroeconomic scenario, sharp rise in
interest rates and volatility in the currency and commodity
markets.
Sectors that mainly contributed to higher NPAs were the priority
sectors (agriculture), construction, metals (iron and steel),
engineering, aviation and infrastructure (specifically, power and
telecom).
Interestingly, despite the rising trend of GNPAs (from 3.3 per
cent as of March 2013 to 4.0 per cent as of December 2013) for
the banking system, the provisioning coverage ratio for public
sector banks has declined to 41 per cent as of December 2013
from 45 per cent as of March 2013, indicating that banks have
not been provisioning adequately for the bad assets.
Lower provisioning also masked the sharp drop in banks' net
profits.
Trend in gross NPA ratio of scheduled commercial banks
Private banks with strong credit underwriting reported lower slippages. For
private banks, this enormous difference reflects better credit underwriting norms,
recoveries and upgradations.
Bank group-wise movement in GNPAs
Rise in restructuring - an increasing risk for PSBs
Post the subprime crisis in 2008, the RBI allowed banks to restructure
stressed assets, while maintaining the asset classification.
The special regulatory treatment allowed for standard accounts helped
banks limit growth in GNPAs.
PSBs accounted for almost 95 per cent of scheduled commercial banks'
total standard restructured assets (Rs 3,100 billion) as of March 2013.
Consequently, for PSBs, the cushion between Tier-I capital adequacy
ratio and unprovisioned assets (defined as the sum of net NPAs and
standard restructured assets) declined sharply to -0.1 per cent as of
March 2013 from 3.4 per cent as of March 2011.
Private banks, on the other hand, have been able to maintain the
cushion at about 10 per cent, owing to higher provisioning and lesser
proportion of restructuring.
Trend in share of restructured assets
Large corporate loans form sizeable portion of restructured assets
The current nature of restructuring is qualitatively different from
that in 2008-09 and 2009-10.
Loans restructured earlier were smaller and represented the
accounts of small and medium enterprises (SMEs).
However, banks are increasingly restructuring large corporate
exposures.
The bulk of assets restructured in the current economic downturn
have a ticket size of more than Rs 10 billion.
The increase in the average ticket size for loans referred to the
Corporate Debt Restructuring (CDR) cell indicates that not only
small borrowers, but large companies too are finding it difficult to
repay loans.
The average ticket size has increased to Rs 14.2 billion as of
December 2013 from Rs 4.7 billion in March 2009.
The fact that more large companies are opting to restructure loans
reflects the stress on their credit quality, which is being affected by
lower profitability, weak demand and tight liquidity.
Over the past few years, the ratio of restructured accounts to gross
advances has been the highest for the industrial sector at 8.2 per
cent (for the medium and large industries sector, the ratio stood at
9.3 per cent).
The ratio of agriculture to gross advances stood at 1.4 per cent,
while that of the services sector stood at 4.0 per cent.
The ratio of the micro and small services to gross advances stood
at 0.94 per cent.
Large corporate loans form sizeable portion of restructured assets
Incremental industry-wise CDR cases for one year ending
December 2013 (value terms)
Yield Analysis
Return on Asset to fall in 2013-14 and remain at low levels
in 2014-15
CRISIL Research expects banks' Return on Asset (RoA) to decline
to 0.7 per cent in 2013-14 from an estimated 1.0 per cent in 2012-13.
The decline will be largely due to the poor performance of public
sector banks who are projected to have 0.5 per cent RoA by March
2014.
We expect that RBI's guidelines on restructuring of advances by
banks and financial institutions would increase provisioning of
banks by Rs 150 billion over April 2013 - March 2015.
A major portion of this incremental provisioning will have to be
done by public sector banks (PSBs), which together accounted for
95 per cent of the restructured assets of the banking system as of
June 2013.
RoA will remain at low levels in 2014-15 as Non-performing
assets (NPAs) are expected to remain at an elevated level for
public sector banks (PSBs).
However, we expect private sector banks to see an
improvement of ~10 basis points in RoAs in 2014-15 due to
better efficiency as well as a strict credit appraisal mechanism.
Return on Asset to fall in 2013-14 and remain at low levels
in 2014-15
Return on Asset
Net interest margin
Net interest margins (NIMs), on the other hand, will decline by
15-20 bps over 2013-14, due to the rising cost of funds and rising
NPAs.
Net interest income for public sector banks has grown at half
the rate of growth in advances.
The significant variation is mainly on account of a substantial
rise in non-interest earning assets (GNPA as well as
restructured loans, which account for about 11 per cent of
advances) and further aggravation on account of pricing
pressure.
While the CASA deposit base is expected to shrink, rising non-
earning assets (Gross NPA) will severely impact profitability of
banks.
Net interest margin
Both the bank groups will witness pressure on NIMs but, the
drop in NIMs of PSBs is expected to be more sharper than that
of private banks.
This is because, many private banks have raised their base rate
in response to the rising cost of funds, while public sector
banks are not expected to do so any time soon.
Also, the gross NPA in case of public sector banks is expected
to move up at a much faster pace than private banks.
However, we expect NIMs to improve by 5-10 basis points in
2014-15 on the back of economic recovery and better pricing
power of banks.
Net interest margin
Net Profitability Margins - Banking system
Yield on advances
With a 100 bps cut in the repo rate during 2012-13, banks also
cut their base rate by up to 50 bps (modal base rate).
As majority of the assets are floating (variable) in nature, the
yield on advances too declined marginally.
With inflation expected to remain high in 2013-14 and 2014-15,
growth in deposits forecast to remain low and no further scope
for repo rate cuts, yields are likely to inch up marginally.
The base rate of PSBs is not expected to go up much.
However, a few private banks have hiked their base rate by up
to 25 bps, post the liquidity tightening measures initiated by the
RBI in July 2013.
Trend in yield on advances
Yield on investments
Yields from investments made by banks hinge upon a mix of
trade and non-trade strategic investments, the maturity profile
of these investments and the interest rates prevalent at the time
of issuance of securities as well as at the time of maturity.
However, for banks, almost 75 per cent of the portfolio is
classified as Held-To-Maturity (HTM).
Thus, the short-term fluctuation in rates is unlikely to have a
significant impact on the profitability of banks as such
securities are not marked to market.
Almost 43 per cent of investments of scheduled commercial
banks (SCBs) is in the over 5-year maturity bucket.
A large proportion of these investments are likely to be
strategic in nature, including investments in subsidiaries.
As of March 2013, about 30 per cent of investments were short-
term (with maturities of less than 1 year), 14 per cent were in
the 1-3 years bucket, and 13 per cent were in the 3-5 years
maturity bucket.
The yield on investments is expected to decline by 30-40 bps in
2013-14, as G-Sec yields fall. G-Sec yields are expected to
remain at similar levels in 2014-15.
Cost of deposits
Bank deposits comprise current deposits, savings deposits and
term deposits.
Current and savings account (CASA) deposits are low-cost
deposits.
While banks do not offer interest on current account deposits,
interest on savings deposits have been deregulated by the RBI
since October 2011.
Interest rates on term deposits are determined by individual
banks based on the tenure.
When credit offtake is high and competing investment avenues
such as mutual funds, stock markets and post office savings offer
attractive returns, banks tend to increase rates on term deposits
to attract customers.
Maturity profile of term deposits with scheduled commercial
banks
In response to rise in short-term market rates and slowing
growth in deposits, banks have increased their deposit rates by
25-50 bps across maturities over the last 6 months.
The full effect of this would be felt in the near term as the hike
in rates has taken place mainly for the shorter maturities.
Consequently, the cost of deposits is expected to remain at
elevated levels of 6.5 and 6.4 per cent in 2013-14 and 2014-15,
respectively .
In the medium term, term deposit rates are likely to stay high,
as deposit growth remains tepid.
Maturity profile of term deposits with scheduled commercial
banks
Cost of deposits for SCBs
Cost of borrowings
As in the case of advances, most bank borrowings are raised on a
floating-rate basis.
Banks borrowings are raised primarily to fix liquidity mismatches,
and hence, are mostly short-term in nature.
CRISIL Research's analysis of maturity profile indicates that 55-60
per cent of borrowings have a tenure of less than 1 year.
Based on the proportion of borrowings from various sources and
the movement in rates for each source, the cost of borrowings is
estimated to decrease only marginally in 2013-14 and 2014-15 as
market rates have declined post RBI easing some of the liquidity
tightening measures.
Cost of borrowings

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Analysis of Banking Industry

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