What the RBI Financial Stability Report says about Indian banks

5 Jul 2023 , 10:08 AM

Since the last FSR was published in December 2022, the Indian banking sector managed to expand its balance sheet, its business (loans + deposits) and its profitability. At the same time, Indian banks saw their gross NPAs and net NPAs declining during this period between December 2022 and June 2023.  What needs to be noted is that, as of June 2023, the gross and net NPAs as percentage of total loans and advances have fallen to a 10-year low while the capital adequacy has risen to a 10-year high. That is surely a positive thought to start off the Financial Stability Report for June 2023.

Charting deposits and credit growth of banks

Deposit growth of banks had moderated in FY22 but in the first half of FY23, the deposit growth spiked to 11.8%. This growth was driven by private banks which saw deposits growing 14.8% in March 2023 quarter while the PSU banks grew deposits at 8.1% with overall commercial banks growing deposits at 10% in the March 2023 quarter. However, the interesting sub-trend is that the growth in CASA has tapered in the March 2023 quarter while the growth in time deposits has spiked sharply. That is hardly surprising as depositors have tried to lock themselves into higher yield time deposits, assuming near-peak rates.

What about credit growth of banks? For the March 2023 quarter, the overall credit growth for all banks stood at a healthy 15.4%. Of these, private banks saw credit growth of 17.3% while PSBs saw credit growth of 14.7%. If you look at the overall mix of the lending portfolio, consumer loans at 31% is the single biggest component of the loan book of banks. The growth in consumer credit for all banks has been 22.2% in March 2023 with PSBs growing consumer credit at 25.7% and PSBs not too far behind at 20.1%. Private banks saw a sharp spike in agricultural credit in the March 2023 quarter.

Charting asset quality of banks as of the close of FY23

This is the area that now only showed improvement but is also at the best levels in the last 10 years. Gross NPAs overall fell to 3.9% for the banking sector as a whole with PSBs reporting gross NPAs of 5.2% and private banks reporting gross NPAs of 2.2%. 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 March 2023, the overall bank net NPAs stands at a healthy 1%, showing substantial provisions already made. PSBs are showing net NPAs at 1.3% while private banks net NPAs are at 0.6%. 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 74%. Within banks, private banks and PSBs have almost a similar PCR converging towards the average. An interesting metrics is the write-offs to gross NPA ratio, which stands at 28.5% for the banking sector overall in the March 2023 quarter. However, while the ratio is just 22.2% for PSBs, it is as high as 47.9% for the private banks. In fact, the write-off to GNPA ratio has risen in FY23, after falling for 3 years 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 7.7% while it is lowest at 1.4% for consumer loans. For the industrial sector, this ratio stands at 5.2% and at 3.9% for the services sector. 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 energy, automobiles, metals, chemicals, and mining. One more good signal is that the gross NPA ratio of large borrowers has been steadily over the sequential four quarters.

How banks measure on capital adequacy and profitability

Capital adequacy measures if the bank has sufficient capital to buffer shocks. For FY23, 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 from capitalization support from the government and the markets. For the banking system overall, the CRAR ratio stands at a healthy 17.1%, the highest level in last 10 years. The private banks have an average CRAR of 18.6% while the PSBs have an average CRAR of 15.5%. 

Let us turn to the earning and the profitability of the Indian banks in the last quarter of FY23 and for FY23 overall. 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 has largely been an outcome of the cost of deposits not keeping 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 improved by 30 bps while the profit after tax (PAT) for the banking sector overall improved by 38.4% yoy. This was an outcome of a sharp spike in NII as well as an expansion in NIMs combined with lower provisioning for NPAs. What is interesting is that the PAT of PSBs grew at a faster rate compared to the private banks. While this can be due to a lower base for PSBs, it is also reflective of private banks seeing operating expenses spike by 29.4% in FY23. 

Let us finally look at some very profound banking ratios on profitability. The net interest margins of the banking sector overall stood at 3.7% annualized with private banking NIMs at a robust 4.4% and PSB NIMs at 3.1%. in the March 2023 quarter, bulk of the earnings growth came from growth in NII, as depicted in the disaggregation of earnings. As a result, the ROE of banks overall for the March 2023 quarter had risen to 12.3% of which private banks had ROE of 13.5% while the PSBs has ROE of 11%. Return on assets overall stood at 1.1% annualized. However, PSBs with ROA of 0.7% lagged the private banks with ROA of 1.6%. Overall, for the March 2023 quarter, the cost of funds averaged 4.4% for the banking sector while the yield on assets averaged 7.7%.

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 (as during the global financial crisis and the COVID crisis), the CRAR would still stay above the statutory threshold. The stress test also shows that under normal conditions, the gross NPAs should taper further from 3.9% to 3.6%. However, in a mild stress scenario, the gross NPA ratio could go to 4.1% and even in an extreme stress scenario the gross NPA deterioration would only be to the tune of 5.1%.

The gist of the Financial Stability Report (FSR) published by the RBI for June 2023 shows that banks have become more profitable with lower asset stress, even as they have grown their asset books at a rapid pace. The only extreme risk scenario highlighted by the FSR is if inflation spikes, coupled with higher borrowing costs. In that case, household finances and repayment capacity could come under stress, impacting the highly lucrative consumer loans business. However, that is an extreme case assumption for now.