What the December 2023 RBI Financial Stability Report says about Indian banks?

2 Jan 2024 , 09:47 AM

What is the RBI FSR all about?

The RBI Financial Stability Report (FSR) is published once every six months. It is published in the end of June to cover the second half of the previous fiscal year and again in December to cover the first half of the fiscal year. The December RBI FSR report covers the first half of FY24 for the period April 2023 to September 2023. One of the most awaited and analysed sections of the RBI FSR is the financial stability segment. Here the banks, NBFCs and other financial intermediaries are evaluated based on the progress in terms of operating margins, net interest income (NII), net interest margins (NIMs), gross NPAs, net NPAs and the outcome of the various stress tests conducted by the RBI. 

Since the last FSR was published in June 2023, the Indian banking sector managed to expand its size, and capital adequacy, while also boosting its net banking spreads and reducing its NPA levels. During the December quarter, the RBI had imposed curbs on consumer lending by banks and NBFCs and that would get reflected only in the next RBI FSR. For the first half of FY24, the banks witnessed growth in deposits and in credit. The credit growth was largely led by lending to the services sector and the growth in consumer loans. Deposits a greater shift towards term deposits amidst rising yields on such FDs.

Charting deposits and credit growth of banks for H1FY24

With the higher repo rates being passed on in the form of higher deposit rates, the growth in deposits veered towards higher yielding term deposits. However, that also meant that the growth in CASA (current and savings accounts) deposits remained tepid for the first half of FY24. The rate of deposit growth in the quarter to September 2023 surged to 13.4%. This was driven by 20.9% growth in deposits of private sector banks, 10.1% growth in deposits of PSU banks and 5.3% growth in deposits of foreign banks. The overall deposit growth rate of 13.4% was sharply higher than the average of the last 3 quarters; which was closer to 10%. The surge in deposits in the latest quarter to September 2023 was also partly due to the merger of HDFC Bank and HDFC Ltd. However, even if you adjust for the merger, the overall deposit growth would only come down from 13.4% to 12.3%. That is still sharply higher than the average of the previous 3 quarters.

What about credit growth of banks? For the September 2023 quarter, the overall credit growth for all banks stood at a healthy 19.4%. Of these, private banks saw credit growth of 30.4% while PSBs saw credit growth of 13.3%. Here again, if you adjust for the HDFC Bank merger with HDFC Ltd, then the overall credit growth comes down from 19.4% to 15.3%. If you look at the overall mix of the lending portfolio, consumer loans at 33.2% is the single biggest component of the loan book of banks. Both private banks and PSBs have seen a sharp spike in personal loans, although the latest RBI regulations on consumer lending should bring this under control. In terms of the sectoral mix of credit growth; the big contributions to growth came from personal loans, loans to services and lending to agriculture. However, growth in lending to the manufacturing sector remained relatively tepid at 6.1% for the September 2023 quarter.

To sum up the credit growth story; the lending momentum has sustained in H1-FY24. However, there has been some moderation of credit by foreign banks and PSBs. The lending growth in H1FY24 was led by lending for personal loans and to the services sector. 

Charting asset quality shifts in banks in H1FY24

This is the area that not only showed improvement but is also at the best levels in the last 11 years. This is true of gross NPAs and of net NPAs (net of provisions). For the quarter ended September 2023, the gross NPAs overall fell from 3.9% in March 2023 to 3.2% in September 2023. The fall has been across private banks, PSBs and foreign banks. for the banking sector as a whole with PSBs reporting gross NPAs of 4.4% as of September 2023 compared to 5.2% as of March 2023. The private banks reported gross NPAs of 2.1% as of September 2023 compared to 2.2% in March 2023; a marginal fall of just 10 bps. Clearly, the legacy problem for PSBs still persists, although the intensity of the problem is much lesser now. If you look at the Net NPAs as of September 2023, the overall bank net NPAs stands at a healthy 0.8% as of September 2023, compared to 1% in March 2023. This is not just an indication of better asset quality but also of higher provisioning. PSBs are showing net NPAs 30 bps lower at 1.0% as of September 2023, while private banks net NPAs are at 10 bps lower at 0.5% as of September 2023. The problem has largely alleviated in the last few years through recoveries and aggressive provisioning.

The provision coverage ratio (PCR) has been consistently gaining ground over the last 4 sequential quarters and now stands at 75.3% in September 2023 compared to 74% in March 2023. Within banks, private banks and PSBs have almost a similar PCR converging towards the average. An interesting metrics is the rise in the write-offs to gross NPA ratio, which has increased by 140 bps sequentially to 29.9% for the banking sector overall in the September 2023 period. This ratio for PSBs has spiked from 22.2% to 29.7% sequentially, while for private banks it has fallen from a high of 47.9% to 30.9%. In fact, the write-off to GNPA ratio has risen in September 2023 for the second quarter in succession.

Let us quickly look at the sectoral mix of the gross NPAs. For the banks overall, agriculture credit has the highest gross NPA to loans ratio of 7.0% in September 2023 quarter, although it has fallen from 7.7% in the March 2023 quarter. Interestingly, the gross NPA ratio is the lowest at for personal and consumer loans at 1.3%, compared to 1.4% in the March 2023 quarter. For the industrial sector, this ratio of gross NPAs has fallen sharply by 100 bps in September to 4.2%, compared to 5.2% in the March 2023 quarter. Even for the services sector, the gross NPA ratio has fallen by 50 bps to 3.4% in September 2023, as compared to 3.9% in the March 2023 quarter. Let us look at stressed assets from a more granular perspective. For the banking sector overall, the maximum asset quality stress is coming from sectors like gems & jewellery, construction, food processing and textiles. The lowest NPAs are visible in chemical products, power, automobiles, mining, petroleum, and metals. One more good signal is that the gross NPA ratio of large borrowers has been steadily falling over the sequential four quarters. Needless to say, PSBs still account for the bulk of the large account gross NPAs, but that is more due to legacy factors, than anything else.

Capital adequacy barometer of banks in H1FY24

Capital adequacy measures if the bank has sufficient capital to buffer shocks. Banks are mandated to keep a certain base minimum capital against their assets under the Basel norms. For September 2023, the capital to risk-weighted assets ratio (CRAR) of the banking sector overall had improved sharply, as had the Tier I ratios. This was due to a combination of improved profits and also capitalization support from the government and the markets. For the banking system overall, the CRAR ratio was slightly lower at 16.8% compared to 17.1% in the March 2023 quarter. In the March 2023 period, the CRAR had touched its highest level in 10 years. The private banks have an seen their CRAR fall by 60 bps to 18.0% while the PSBs have seen average CRAR dip by 30 bps to 15.2%. In both cases, the marginal fall in CRAR can be attributed to the frenetic growth in credit assets during H1FY24.

How bank profitability panned out in H1FY24

Let us turn to the earning and the profitability of the Indian banks in the first half of FY24. In the last few quarters, we have intuitively seen Indian banks (both PSBs and private banks) reporting sharply higher NII (net interest income) as well as a rapid expansion in the NIMs (net interest margins). This is largely because the cost of deposits did not keep pace with the pricing of loans. Even if that moderates, the overall NIMs are expected to stay higher than what it was about a couple of years back.

For FY23 overall, the NIMs fell marginally to 3.6%. The net interest margins of PSBs were stable at 3.1%. However, the private sector banks saw their NIMs taper sharply from 4.4% to 4.0%. This is largely because, the private banks have been more aggressive about raising the deposit rates and that has compressed margins for the PSBs faster. However, the moderation in NIMs was expected. The profit after tax (PAT) for the banking sector overall improved by 43.0% in the September 2023 half compared to growth of 38.4% in the March 2023 half. What about the return on equity of banks. For the September half, ROE of the banking system as a whole improved by 60 bps to 12.90% compared to 12.30% in the March 2023 half. The private banks saw ROE improving from 13.5% to 14.2% sequentially, while the growth in ROE for PSBs was from 11.0% to 12.3%. 

Return on assets for the banking system improved by 10 bps to 1.2% in the September 2023 half. PSBs witnessed ROA improving from 0.7% to 0.9% sequentially. Even private banks saw ROA improving by 10 bps from 1.6% to 1.7%. This is one area where the private banks lead the PSBs by a margin. With rising deposit rates, in tandem with higher repo rates, the cost of funds of the banking system has gone up sharply by 80 bps from 4.4% to 5.2% sequentially. The spike in cost of funds was across the board. However, this was largely compensated by the sharp spike in the overall yield on assets of banks to 8.4%, which showed the impact of repricing cost of loans higher as well as higher yield on investments.

Good news from the stress tests of banks

Finally, the real good news is from the stress tests of Indian banks. The results reveal that the banks (both PSBs and private banks) are adequately capitalized and can absorb macro shocks over the next one year, even in the absence of any fresh capital infusion. Even in a severe stress scenario, the CRAR would still stay above the statutory threshold. The stress test also shows that under normal conditions, the baseline CRAR would be around 14.8%. However, this could fall to 13.5% in a medium stress situation and fall further to 12.2% in an extreme stress situation. However, that is still above the threshold. The gross NPAs would be at around 3.1% in a baseline scenario. However, in a mild stress scenario, the gross NPA ratio could go to 3.6% and even in an extreme stress scenario the gross NPA deterioration would only be to the tune of 4.4%. Even in an extreme risk situation, the impact on the overall gross NPAs is only going to be limited.

The Financial Stability Report (FSR) published by the RBI in December 2023 pertains to the first half to September 2023. It indicates that banks have become more profitable with lower asset stress, even as they have grown their asset books at a rapid pace. The two risk factors, as we see it is, if the cost of funds goes up further for the banks and the other risk factor is if the fast-growing consumer loans portfolio of banks starts showing stress. In that case, household finances and repayment capacity could come under stress. However, with the RBI being proactive, that looks like a very remote possibility as of now!