Tuesday, May 21, 2024

Why the government’s review of state-owned banks makes sense

Indian banks, particularly those owned by the government, aren’t as safe from higher interest rates as the Reserve Bank of India (RBI) would like everyone to believe. Finance minister Nirmala Sitharaman knows this. That’s why the government – the promoter of several banks in India – has been quick to carry out a review of the banks it owns following the collapse of Silicon Valley Bank and a few other banks in the US. That’s not to say there were similar concerns of a run on banks in India, especially those that have the protection of the sovereign.

Yet, sensibly, the finance minister has sought an assessment of the strategies in place were a similar crisis to hit these lenders. Public sector banks have been told to diversify their assets and liabilities and bolster their risk management so they are well equipped to counter potential crises and the challenges posed by rising global interest rates and a slowing economy.

India does not have SVB-type specialist or sectoral banks, or a similar banking landscape to the United States, which has hundreds of small banks and regulation at the federal and state level. Deposits aren’t as concentrated in tech firms or startups, as was the case with SVB, which was one of the triggers for its collapse.

These developments also come at a time when Indian bank balance sheets look far healthier than they were a few years ago. Gross Non Performing Assets or bad loans are significantly lower than they were during the first term of this government. They comprised just 5.53% of total loans at the end of December 2022 while the capital adequacy ratio (CAR) was close to 15%.

Demand for bank loans has also been relatively high at over 15 % this month – a reversal of the single-digit growth that Indian lenders reported earlier as banks set about expending capital and cleaning up their balance sheets.

Naturally, CEOs of state-run banks were quick to certify their robustness and resilience. Adding to their comfort was the Financial Stability Report of the RBI in June 2022, which said that macro stress tests for credit risk indicated that state-owned banks would be able to comply with the minimum capital norms even in the face of severe stress.

They are now expected to show the government detailed plans for handling potential risks and diversifying their assets and liabilities. But it’s crucial that no attempts are made to hide, underplay, understate or mask any weaknesses.

A State Bank of India (SBI) report in November 2022 flagged the issue of inadequate pricing risks on both assets and liabilities – loans and deposits. The SBI Economic Report pointed out that short-term working capital loans for less than a year were being approved at less than 6% while 10-year and 15-year loans were being priced at lower than 7% – that too in a scenario where banks have been competing fiercely to mobilise deposits amid rising interest rates.

In the case of SVB, the primary trigger for the collapse was the rapid rise in interest rates, which cut the value of its long-dated US securities. In comparison, Indian banks have some protection from this as they don’t have to mark down the value of securities bought between 1 April 2022 and 31 March 2023. That was done to help the government manage its huge borrowing programme and keep costs lower when there was little appetite for such borrowing.

It was during this period that the RBI, which now talks of the virtues of the bond yield as a public good, bumped up the percentage of bonds that could be held by banks in what is known as the held-to-maturity (HTM) category to 23% of deposits. This was done to help the government’s borrowing plans go through and was a clear abuse of the RBI’s advantage in the market for borrowings as the government’s debt manager.

But from the June 2023 quarter onwards, this limit of 23% will be lowered in phases to 19.5%. Worries could centre around the portfolio of some state-owned banks, which may have bonds in excess of 23% and could possibly book losses on a part of their portfolios because of higher interest rates.

The other challenge will be on the liquidity front after the huge surplus last year and deposit growth, which now lags the pace at which loans are approved and disbursed. It would, therefore, make sense for the government to settle for conservative pickings from the banks it owns rather than seek more profits in return for infusing a lot of capital. That can wait until these lenders ride out another challenging year and build extra capital buffers. The payoff from the clean-up of bank balance sheets, which started a few years ago, will be clear then.

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