India’s banks spent most of the past decade out in the wilderness, as a punishment for the lax underwriting standards on their corporate loans. Now they have regained their health, restored profitability and reestablished investors’ trust. The benchmark NIFTY Bank index is close to an all-time high.
With everything going well, the lenders should be turning cautious, but recent full-year results show an opposite trend — provisions for future loan losses are beginning to decline. This might not be prudent.
Across most of Asia, muted big-ticket consumer expenditure — such as on housing — and restrained capital expenditure by firms have led to only a mild post-pandemic recovery in credit, which makes India’s double-digit loan growth a notable exception, economists at Australia & New Zealand Banking Group Ltd said.
Just last month, New Delhi-based developer DLF Ltd sold US$1 billion worth of luxury homes on the outskirts of the national capital in 72 hours. A one-year, 29 percent jump in credit-card debt has made even the Reserve Bank of India a little uncomfortable. The central bank has cautioned lenders about the risk of delinquencies on their unsecured loans at meetings over at least the past three months, Reuters reported recently.
Yet HDFC Bank Ltd and ICICI Bank Ltd, two of the country’s largest lenders by market value, slashed their loss provisions by 23 percent for the financial year that ended in March. The money ICICI has set aside cumulatively is now 9 billion rupees (US$110.1 million) less than a year ago. That is not a problem yet, because gross nonperforming assets have declined at a faster pace of 27 billion rupees.
However, there is nothing to suggest that they might not rise again.
With the incremental credit-to-deposit ratio running at 111 percent, Indian banks must pay more to savers — sacrificing some part of their high profitability — although even this might not affect all lenders equally.
Higher deposit costs “will tip the scale in favor of our rated banks, allowing them larger bargaining power to price the loans and hence to defend their margins,” Moody’s Investors Service senior analyst Rebecca Tan said.
However, problems could erupt elsewhere.
“The key risk we are watching really is the quality of these bank loans to small and medium-sized enterprises, and that’s predominantly because of the current rising rate environment,” Tan said in a Bloomberg TV interview last month.
Since then, an unexpected pause in monetary tightening by the central bank has provided some reprieve, although the effects of a cumulative 250-basis-point increase in rates is likely to be felt for some more time.
HIGH-RATE WORRIES
High interest rates might be particularly worrisome for the risk-chasing behavior of non-bank financial institutions, or NBFIs, which do not have access to low-cost deposits.
“We believe more NBFIs are pursuing higher-yielding loans to offset greater pressure on funding costs and net interest margins,” Fitch Ratings said on Thursday.
Aggressive growth could “pressure lenders to take inordinate risks, which could weaken asset quality and credit profiles when the economic cycle turns,” it added.
Banks are not oblivious to the danger. Excluding retail and rural lending, ICICI now has only 0.8 percent of its loan portfolio exposed to riskier firms rated BB or below. Two years ago, the figure was as high as 3.6 percent. Axis Bank Ltd, the fifth-largest lender, did not have to utilize its COVID-19-related loss cushion in the March quarter.
As a result, even with a 64 percent drop in full-year provisions, it still has gross bad loans covered to the extent of 145 percent.
However, all of this is backward looking. The retail loan book for both HDFC Bank and ICICI has grown by 1 trillion rupees apiece over the past 12 months. Axis saw a nearly 900 billion rupee increase, while Bajaj Finance Ltd, a specialist non-bank lender to consumers and small firms, expanded its assets by about 500 billion rupees. Retail credit by just these four Indian lenders has expanded by almost the same amount in one year as the entire growth in the Thai banking system over the past four, yet Bajaj also has cut back on loss provisions by 34 percent.
Clearly, strong profit growth has put Indian financiers’ optimism in overdrive, but is it sustainable? The previous bout of unbridled enthusiasm for corporate lending ended with more than US$200 billion in non-performing assets, one of the world’s worst piles of bad loans.
This time around, individuals’ data has replaced collateral of plants and machines.
CYCLE TURNING
Digital lending is the new mantra. The belief seems to be that any lender whose portfolio of unsecured retail loans is not increasing by 50 percent annually is simply not trying hard enough.
However, consumer demand is being led by a small pocket of affluence. The 6.5 percent growth in GDP that the Indian government is penciling in for the fiscal year that began this month faces several risks. Turmoil in the US banking industry is making India’s US$245 billion software-export industry loomy. A sustained rise in oil prices, currently kept in check by global growth concerns, would crimp already-limited purchasing power of urban low and middle-income workers amid high unemployment.
Meanwhile, climate change could dash any hope of a recovery in stagnant real wages in rural areas. Summer temperatures are above normal by about 5°C in many parts of the country. Heat waves could damage crops and cause power shortages.
It is time that lenders behaved more prudently. The aggregate bad-loan ratio of 4.41 percent at the end of last year was the lowest since March 2015.
The system has “remained resilient and not been affected by the recent sparks of financial instability seen in some advanced economies,” Reserve Bank of India Governor Shaktikanta Das said in an online talk on Thursday.
Still, the central bank has “started looking at the business models of banks more closely,” he said.
As it indeed should. For years, the stock market could not expect even 1 percent return on assets from a vast swathe of the Indian banking industry. Now that things have changed, 2 percent should be good enough for investors — with the rest of the profit kept aside to deal with future losses.
Unusual as it is from a regional perspective, the credit upswing in India might not be at a risk of abrupt reversal — but since it is a cycle, at some point it will turn.
Andy Mukherjee is a Bloomberg Opinion columnist covering industrial companies and financial services in Asia. He previously worked for Reuters and the Straits Times.
This column does not necessarily reflect the opinion of the editorial board or Bloomberg LP and its owners.
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