The buzz around consolidation of PSU banks has been doing the rounds for a while now. This is a dire need as the sector as a whole is fast losing its relevance in the Indian financial system. In a study on listed banks we did post first quarter earnings, one can clearly spot the great divide. So, do not fret about paying a premium for the efficient private players.
Q1 FY18 profit solely driven by handful private banks
Indian-listed banks reported an aggregate after-tax profit of Rs 11,210 crore for the quarter ended June, 2017. Out of this, the contribution of the seventeen listed private sector banks was Rs 11,511 crore (more than 100 percent) as the public sector reported an aggregate loss of Rs 307 crore. If we exclude SBI, which reported a profit of Rs 2005 crore mainly on account of an adjustment in the provisioning line, the picture from the PSU pack looks grim.
The top eight contributors to banking sector’s profitability have been private sector entities, with the lone exception of SBI.
Asset quality woes had an overbearing impact on the numbers. If we look at the systemic gross delinquency, much of it rests on the books of PSU banks. Also, contrary to perception about an improvement, there has been a 17 percent sequential uptick in the gross NPA of the banking system. The share of PSU banks in the same has risen to 88.4 percent in Q1 FY18 from 87.1 percent in the previous quarter, largely due to the unexpected retail slippage from SBI.
Do PSUs still dominate the credit market?
Despite the asset quality woes, the general impression is public sector banks still dominate Indian banking. However, an in-depth analysis of data dispels this myth. In the aggregate credit of the banking sector (Rs 77 lakh crore), the share of the public sector bank is still at 70 percent, with private entities taking up the remaining 30 percent. But the picture is just the reverse if one looks at incremental credit.
In every incremental Rs 100 that the banking sector is lending now, Rs 67 is coming from the private sector players and only Rs 33 is coming from public sector banks. At this pace, in a few years, private sector’s absolute share will surpass that of its public sector counterparts.
In the past one year (from June 16 to June 17), the incremental credit market was clearly dominated by the private players. For investors this matrix beckons attention.
CASA not a problem
In the new regime of marginal cost of fund-based lending (MCLR), access to low-cost deposits (CASA) differentiates the men from the boys. However, going by that parameter, public sector banks are well placed. The average CASA for the public sector banks at 35 percent is still a tad higher than the private sector counterparts at 33 percent.
So, why are they credit-shy?
Clearly, the burden of the non-performing assets and provisions and the precarious capital position of the PSU banks are to blame. Barring a handful that have succeeded in raising capital in recent times, most banks do not have the ability to lend. It is a strange vicious cycle, where banks saddled with bad assets have higher provisioning requirement that is eating into profitability. This is weakening their capital position further and thwarting their ability to lend.
In fact, while the average capital adequacy of the private sector banks is a healthy 14.8 percent, for public sector banks it is 11.6 percent. The average gross NPA of public sector banks is 14.5 percent which is 3.7 percent for private banks. As the exhibit shows, most weak banks have a lethal cocktail of weak assets and weak capital, and perhaps will be out of the credit market before long. The share of this pack in banking system’s absolute advance is close to 17 percent. This spells a big opportunity for the efficient financial intermediaries from both the banking and non-banking space.
PSU banks still have a large market share in deposits. They have a share of 75 percent in absolute deposits and 62 percent in incremental deposits. However, weighed down by asset quality they are resorting to lazy banking which is clearly borne out in the falling credit to deposit ratio that stands at an average of 70 percent which is 83 percent for their private counterparts.
It is noteworthy that while optically many of these banks look attractively priced on price to book, if we adjust for the net non-performing assets (the part of the non-performing assets that is not provided for), some of these banks have completely eroded their capital base.
No wonder, the regulator time and again has been raising the issue of ineffectiveness of the rate transmission mechanism till asset quality issues are resolved.
While the resolution mechanism is kicking into high gear, does it make PSU banks an attractive option?
Barring a few, the answer is no. Most of them at best are no more than short-term trading bets. Given the altered market share dynamics, most PSU banks will be rendered irrelevant.
The fundamental picture has undergone a dramatic change with efficient private banks driving the growth in banking sector credit. So while PSU banks may trade below book, cheap is not necessarily a virtue in this case. Money will still be made by investing in efficient banks and NBFCs that are quoting at a premium.