Profitability pressures continue

Prolonged slowdown in general macroeconomic conditions has impacted business and

profitability of SCBs over the last few years. The total income of Indian banks, that grew
phenomenally by 29.7% in FY12, has slowed down to 16.2% in FY13. Total income of
PSBs grew 12% in FY14 compared with 14.3% in FY13. Total income of private sector
banks grew 14.5% in FY14 compared with 23% in FY13. Net Interest income of Indian
banks, that grew by 15.8% in FY12, has slowed down to 10.8% in FY13 and has revived
to 12.8% in FY14.
The profitability of Indian banks continues to be under increasing pressure. In FY14, net
profits of SCBs declined by 13.8% as against a growth of 12.9% in FY13. Lower yield on
advances and higher provisions for bad loans were the key factors weighing on the
profitability of SCBs.

The profit after tax (PAT) growth of different bank groups varies significantly. The new
private banks were able to maintain a healthy growth in their PAT at 19.7% in FY14
against a contraction of 30.7% of public sector banks. The poorer financial health of
public sector banks compared with the new private banks was primarily owing to lower

growth in income and higher provisioning. The net interest income of public sector banks
grew 12.2% in FY14 as against a much higher 19.1% growth of new private banks. This
was due to lower credit growth and income losses on account of higher stressed
advances. On the other hand, the risk provisions of public sector banks increased to
44.8% of their earnings before provisions and taxes (EBPT) in FY14 (as against 36.9% in
FY13), whereas they declined for new private banks to 6.4% of their EBPT in FY14 from
11.9% in FY13.
Concomitantly, the contribution of public sector banks to total PAT of SCBs declined
from 68.9% to 41.5% between Mar 2010 and Mar 2014. However, their share in the total
assets of SCBs has not changed much.
Return on Assets (RoA) and Return on Equity (RoE), the two major indicators of
profitability, have also reflected declines over the past few years. Return on Assets
(RoA), has declined to 0.8% in FY14 compared with 1.1% in FY13. On the other hand,
Return on Equity (RoE) saw a steeper decline to 9.5% in FY14 from 12.9% in FY13.
Capital adequacy ratios under stress
The capital to risk weighted assets ratio (CRAR) for Indian banks under Basel III as at
end-March 2014 stood at a comfortable level of 13%. Despite the drop in their financial
performance due to slowdown in credit growth and higher interest expenditure, Indian
banks remained adequately capitalised. CRAR of SCBs under Basel II increased
marginally from 14.19% in FY11 to 14.24% in FY12, indicating the healthy capital
position of Indian banks. However, CRAR under Basil II declined to 13.9% in FY13.
This decline in capital positions at the aggregate level was majorly because of
deterioration in the capital positions of public sector banks.
The Basel III capital regulation has been implemented in India effective Apr 01, 2013,
which will be fully implemented in a phased manner by Mar 31, 2019. Although Indian
banks are well capitalised, going ahead, there will be a need for raising additional capital
to comply with the Basel III requirements. According to some rough RBI estimates based
on a set of assumptions, Indian banks additional capital requirements will be to the tune

of ` 4.95 trillion over the period of phasing in of the Basel III requirements. This estimate
does not include the impact of comprehensive pillar II capital add-ons under Basel III,
which Indian banks have not been subjected to so far.
To adopt Basel III norms, PSBs alone will require an additional capital to the tune of `
4.15 trillion over the period of the phasing in of Basel III, of which equity capital
accounts for ` 1.43 trillion, while non-equity capital will be of the order of ` 2.72 trillion.
The governments contribution to PSBs equity capital will be of the order of ` 900 bn at
the existing level of the governments shareholding.
Asset quality concerns looms large
Before 2008, asset quality of SCBs was improving on a secular basis, following
implementation of Prudential Guidelines. The GNPA ratio had declined sharply from
12.7% as at end March 2000 to 2.5% as at end-March 2007 and thereafter, this ratio has
been largely flat until March 2011. A key feature discernible in the banking industry since
FY12 is the gradual contraction in the growth of credit and growth in NPAs showing a
sharp spurt. The slowdown of the Indian economy while impinging credit growth has also
had a strong bearing on revenues of firms, thereby, weakening their repayment capacities.
A number of companies/projects are under stress and the investment related policy logjams are only preventing companies from making new investments, fearing higher costs
due to delays. Consequently, the Indian banking system has seen an increase in NPAs and
restructured accounts during the recent years. Gross NPAs of the banking sector increased
from 3.4% of total credit advanced in Mar 2013 to 4.1% of total credit advanced in Mar
2014. The net NPA as percentage of total net advances also increased to 2.2% in Mar
2014 from 1.7% in Mar 2013.
The GNPAs of public-sector banks (PSBs) have shown a rising trend, increasing by
almost four times from Mar 2010 (` 599.7 bn) to Mar 2014 (` 2,042.5 bn) (provisional).
As a percentage of credit advanced, NPAs of PSBs stood at 4.7% in Mar 2014 compared
with 2.2% in FY10.

The significant deterioration of asset quality of the banking system has led to an increase
in the total stressed assets in the banking system (NPAs plus restructured assets).
Amongst banks groups, PSBs had the highest level of stress in terms of NPAs and
restructured advances. Public sector banks continued to register the highest stressed
advances at 11.7% of the total advances as on Mar 2014, followed by old private banks at
5.9%. Industries such as infrastructure, iron and steel, textiles, mining, and aviation
account for a significant share of total stressed assets (NPAs and restructured advances)
of public sector banks. While share of advances to infrastructure continued increasing,
albeit slowly (the share of the other four sub-sectors have dropped), from 13.5% in Mar
2011 to 14.4%, in Mar 2014; infrastructure as a share of stressed assets, has increased,
from 8.4% to 29.2%.
Steep rise in the growth of restructured debt
In recent years there has also been a sharp increase in the amount of debt restructured
under the corporate debt restructuring mechanism. This has implications for the banks
already stressed asset quality in the period ahead. Significant increase in restructured
asset as indicated by higher Corporate Debt Restructuring (CDR) also points towards
worsening asset quality of Indian banks.
Number of cases approved for CDR increased to 476 in FY14 from 401 in FY13.
Aggregate debt that was brought under CDR mechanism increased by 44.3% in FY14
over previous year to reach ` 3,304.4 bn. Maximum distress in debt was seen in iron &
steel sector and infrastructure sector. High exposure to projects in infrastructure and the
iron & steel sector is the primary reason for higher NPAs for public sector banks.
With continued deceleration in the industrial growth, pick-up in activity in the
infrastructure and iron & steel sectors is expected to be delayed. Since concentration of
distressed assets is higher in these sectors, asset quality of Indian banks is set to worsen
further. However, effectiveness of the new government in clearing stalled infrastructure
project would play a major role in determining the asset quality of the banking sector,

going ahead. A faster clearance rate would help Indian banks contain the pace of growth
of distressed loan assets.
Financial Inclusion Plans (FIPs) to continue to improve accessibility of rural
population to banking services
FIPs which was approved and adopted by SCBs in 2010 for a period of three years (201013) to improve financial inclusion is set to continue. Under FIP (2010-13), almost all
unbanked villages with a population more than 2000 have been covered with a banking
outlet.
Following is a snapshot of the progress made by banks under the FIP during the period
from Apr 2010 to Mar 2014:

Banking outlets in villages have increased to 383,804 in Mar 2014 from 268,454 in Mar
2013 from 67,694 in Mar 2010.

Basic Savings Bank Deposit Accounts (BSBDAs) stood at 182 mn in Mar 2013 which
further grew to 243 mn in Mar 2014.

About 7,400 rural branches have been opened during 2010-2013 compared with a
reduction of about 1,300 rural branches during the last two decades.

The above statistics point towards the effectiveness of FIPs in penetrating rural areas and
improving the financial inclusion in the country. This success has prompted central banks to
continue with the FIP policy. FIP 2013-16 would focus on increasing banking presence in
villages having population below 2,000.
Competition in the banking sector to intensity
To promote financial inclusion and make the sector competitive, RBI has invited applications for
granting new banking licenses. After withdrawal by two applicants, 25 applications have been
considered. The RBI has granted in-principle approval to two applicants to set up banks under
the Guidelines on Licensing of New Banks in the Private Sector. Entry of new players would

increase the competition in the sector, thereby increasing the choice for customers as well as
introduction of innovative financial products and services.
Budget Outlook
The Budget has enunciated a host of new ideas and initiatives that will have a long-term impact
on reviving economic growth, going forward. The focus on infrastructure (rural) and reforms has
set the tone for a revival in aggregate demand as well as gradual recovery of economic growth.
As the economy recovers, investment demand and the need for credit will pick up. The RBIs
decision to cut the statutory liquidity ratio (SLR) by 50 basis points to 22.5% from 23% while
keeping key policy rates unchanged in the recent monetary policy could be viewed as its
optimism regarding growth revival.
However, any meaningful recovery in banking industry would be contingent on reduction in
asset quality pressures. Further, the effectiveness of various measures to improve the asset
quality of banks will depend on the efficient functioning of the CDR mechanism and debt
recovery tribunals (DRTs).