10 Nov 2008, 0548 hrs IST, karan sehgal, ET Bureau
[image: Banking Sector]
Worldwide, banking is one of the most cyclical and risk-prone sectors of the
economy. Due to its dependence on the credit market for earnings growth, the
banking sector is one of the most vulnerable in an economic downturn and
credit crisis and vice versa.
While a manufacturing company with fixed assets like plant and machinery can
remain intact by simply cutting down on optimal capacity in a downturn,
banks will have to write-off assets (i.e. loans) if the borrower fails to
pay up or goes bankrupt. Perhaps, this is the reason behind the bloodbath
seen in banking stocks since the beginning of this year.
Surprisingly, Dalal Street's disappointment with banking stocks is hardly
reflected in the earnings of banks. For instance, in the quarter ended
September '08, the aggregate profit of banks grew at 24.3% — higher than
that seen in the June '08 quarter. So, how have banks shown such impressive
numbers?
An obvious reason is that the loan books of most banks have grown at similar
rates in the September '08 quarter as in the previous few quarters. This
explains why their growth doesn't look constrained by the global financial
crisis, so far. The other not-so-obvious reason is that the deposits of
these banks have grown at a much lesser rate than their loan books.
The adjacent chart shows a dramatic increase in the credit-deposit ratios
(CD ratio) of three of the largest banks in the past three quarters. This
shows that banks are not borrowing as heavily as they are lending. This
helps them to save the interest cost on deposits, which obviously boosts
profits.
But is a rising CD ratio good news? To a certain extent, the answer is yes,
as it shows that banks have done almost everything possible within their
means to keep the profit numbers high. However, high CD ratios, as in the
case of State Bank of India (SBI) and ICICI Bank, indicate that either these
banks will now have to mobilise deposits by offering higher interest rates,
or curtail their loan growth in the forthcoming quarters. This is exactly
what ICICI Bank is doing. It has gone slow on loan growth to a point where
existing deposits are sufficient to maintain a steady state.
Banks are also governed by statutory liquidity ratio (SLR) requirements,
wherein a certain minimum percentage of their current and time deposits have
to be invested in government securities (GSecs). At present, the SLR stands
at 24%, which means a bank can lend a maximum of 76% of its deposits.
Then how do certain banks have CD ratios in excess of 76%? In such cases,
banks lend from their internal accruals as well. Earlier, banks had invested
more in G-Secs than required by SLR regulations. When credit demand
increased, banks liquidated their investments in G-Secs and increased their
lending to retail and corporate borrowers. However, as of now, most of the
big banks have invested just about sufficient funds in G-Secs, which shows
they can no longer liquidate the investments and lend more.
So, in the coming quarters, it seems that banks will have to step up deposit
mobilisation if they are keen to grow their loan books. ICICI Bank, with a
CD ratio of close to 100%, will face a challenging scenario and profit
growth will come only if it increasingly rationalises its expenses or grows
its other income.
Other banks are not as vulnerable, but a bank like SBI will also face a
tough time as its CD ratio is close to 80% and it is unlikely to register a
growth of 40% in its profit as seen in the September '08 quarter.
On the other hand, Axis Bank's CD ratio has fallen to 66.9% at the end of
the September '08 quarter — among the lowest in the industry.
This shows that the bank has enough headroom, and even if the interest
rategoes up, it can slow down the deposit growth and still increase
the advances
at a higher rate to post a higher growth in net profit. Similar is the case
with Punjab National Bank (PNB), which has a CD ratio of 70%.
The improvement in CD ratio was one of the most important factors behind the
above-average performance of banks in the first two quarters of FY09. But
the scope for further improvement is limited. It seems that in the next two
quarters, banks will have to grow their deposits at a higher rate than the
first half, which may adversely affect their profitability. That may be the
reason why the stock market didn't give too much importance to the sector's
impressive earnings growth in the first half of the current financial year.
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Thanks
Adi
http://groups.google.co.in/group/india-investor-forum
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