What June 2024 RBI Financial Stability Report says about Indian banks?

5 Jul 2024 , 09:20 AM

GIST OF THE RBI FSR REPORT PUBLISHED IN JUNE 2024

The RBI Financial Stability Report (FSR) is published twice a year. The first report for the financial year is published in December, covering data up to end of H1 (September). The second FSR is published by the RBI towards the end of June, covering the 6 months and the full fiscal year period till March. Accordingly, the RBI recently published the Financial Stability Report (FSR) for the half year ended March 2024. This June 2024 report covers the banking update upto March 2024 period. Of course, as the name suggests, the FSR uses a slew of parameters including operating margins, net interest income (NII), net interest margins (NIMs), gross NPAs, net NPAs etc and their progression over the previous reading. In addition, the results of the various stress tests conducted by the RBI are also divulged, which shows how resilient the banking system can be in a worst-case scenario.

Since the last FSR was published in December 2023, the Indian banking sector managed to expand its business quality in terms of capital adequacy, profitability, and asset quality. In the December report, we had mentioned that the RBI had imposed curbs on consumer lending by banks and NBFCs. We had also mentioned that these measures would get reflected only in the next RBI FSR for the second half of FY24. Now that the FSR of the second half of FY24 is also out, it is evident that the impact for banks has been only on select loans, which are not a very large part of their exposure. However, the impact has been a lot more pronounced on the NBFC segment. These NBFCs saw a distinct moderation in personal loans and consumer as a result of the RBI strictures. However, the good news is that, even for NBFCs, the asset quality showed an improvement in the second half. Here is a quick look at how the second half of FY24 fared for banks in terms of performance.

CHARTING DEPOSITS AND CREDIT GROWTH OF BANKS FOR H2FY24

In the last few quarters, the big challenge for the Indian banking system was that loan demand was growing at a frenetic pace, but deposits were not keeping pace. The reasons are not hard to fathom. Deposit rates did not rise in tandem with the lending rates. That left a huge gap. While the gap boosted profits for banks, it also created a skew, in which the growth in deposits lagged the growth in loans. Things appear to have changed in the second half of FY24 with deposits also showing distinct signs of picking up.  The rate of deposit growth in the quarter to March 2024 was almost flat at 13.5%. This was driven by 20.1% growth in deposits of private sector banks, 9.6% growth in deposits of PSU banks and 15.1% growth in deposits of foreign banks. The overall deposit growth rate of 13.5% was at par with the September 2023 half, but sharply higher than the previous three periods. The surge in deposits in the latest quarter to March 2024 was still partly due to the merger of HDFC Bank and HDFC Ltd. Six months back, net of the HDFC merger, the deposit growth would have fallen from 13.4% to 12.3%. For the second half of FY24, the netting of the HDFC effect only reduces the deposit growth rate from 13.5% to 13.2%. That means; compared to the first half, the actual traction in genuine deposits is much higher, which is the good news.

What about credit growth of banks? For the March 2024 half, the overall credit growth for all banks stood at a healthy 19.2%, which is 20 bps lower than the sequential September 2023 half. Out of the 19.2% credit growth in March 2024 half, private banks saw credit growth of 28.3% while PSBs saw credit growth of 13.8%. Here again, if you adjust for the HDFC Bank merger with HDFC Ltd, then the overall credit growth comes down from 19.2% to 16.0%. In this background, the credit/deposit gap does not look too jarring. What about the break about the credit portfolio of banks? If you look at the overall mix of the lending portfolio, consumer (personal) loans at 32.9% is the single biggest component of the loan book of banks. However, the good news is that both private banks and PSBs have seen a sobering of personal loans in the overall credit mix. This is largely on account of the RBI regulations on consumer lending. 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 6.5% for the March 2024 quarter.

To sum up the credit growth story; the lending momentum has sustained in H2-FY24. There is clear moderation in the personal loans and consumer loans portfolio of Indian banks, especially the PSBs and the private banks. However, it is personal loan growth at 8.5%, that continues to drive the growth alpha for the banking loan book. That is not likely to change in a hurry. Clearly, the risk of too much consumer debt remains.

CHARTING ASSET QUALITY SHIFTS IN BANKS IN H2FY24

Asset quality is typically measured by the gross NPAs and the net NPAs (after provisions). While gross NPAs shows the size of the problem, net NPAs show the vulnerability of the banks to the NPA problem. For the March 2024 period, the gross NPAs and the net NPAs moderated to their lowest levels in the last 12 years. For the half year ended March 2024, the gross NPAs overall fell from 3.2% in September 2023 to 2.8% in March 2024. The GNPA overall has fallen a full 100 bps in the last one year. The fall in GNPAs has been across private banks, PSBs and foreign banks. Here is the break-up. The PSBs reported gross NPAs falling from 4.4%  in September 2023 to 3.7% as of March 2024. PSB GNPAs have fallen 150 bps in the last one year. The private banks reported gross NPAs falling from 2.1%  in September 2023 to 1.8% as of March 2024. Private banking GNPAs have fallen 40 bps in the last one year. The foreign banks also reported lower GNPAs at just 1.2% in the latest half year to March 2024, consistently lower on a sequential basis. It looks like the PSBs are rapidly coming out of their legacy problems of NPAs, and the intensity of the problem is much lower now. If you look at the Net NPAs as of April 2024, the overall bank net NPAs stands at a healthy 0.6% as of March 2024, compared to 0.8% in September 2023. It is down 40 bps in the last one year. As we mentioned early, the net NPAs is a measure of asset quality and also the extent of provisioning. Net NPAs were lower across PSBs, private banks and foreign banks too, which shows healthy amount of provisioning done.

Another way to look at the net NPAs is via the provision coverage ratio. The provision coverage ratio (PCR) has been consistently gaining ground over the last 4 sequential quarters and now stands at 76.4% as of May 2024, compared to 75.3% in September 2023 and 74% in March 2023. It is progressively higher. Within banks, private banks and PSBs have almost a similar PCR converging towards the average. An interesting metrics is the sobering the write-offs to gross NPA ratio, which had increased by 140 bps sequentially in September 2023 to 29.9%, but has now fallen by 100 bps to 28.9% in the half year ending March 2024. Interestingly, between September 2023 and March 2024, the write-off to gross NPA ratio for PSBs actually fell from 29.7% to 26.3%. In the same period, the ratio of write-offs to gross NPAs for the private sector banks has risen from 30.9% to 38.0%.

WHAT WE READ FROM THE SECTORAL MIX OF GNPAS IN H2FY24

There are a few interesting thing that come out of the sectoral trend of GNPAs. Agriculture continues to show the highest stress at 6.2%, while personal loans have the lowest stress at 1.2%. industry and services have a GNPA ratio overall of 3.5% and 2.7% respectively. Clearly, it is personal loans, that has been contributing to the lowering of NPAs. Where are the likely pockets of stress in the personal loans category, where banks have to be watchful about? Credit card NPAs are in double digits for the PSBs, followed by education loans. For Private banks, the overall stress is relatively lower, although education loans remain challenge. In the overall personal loan book of banks, the maximum percentage stress is coming from the education loans business.

CAPITAL ADEQUACY BAROMETER OF BANKS IN H2FY24

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 March 2024, the capital to risk-weighted assets ratio (CRAR) of the banking sector overall was stable, including the Tier I ratios. This was due to a combination of improved profits and also capitalization support from the government and the markets. However, there was a dichotomy. While the capital adequacy of PSBs improved over last half, the capital adequacy of private banks and foreign banks tapered. For the banking system overall, the CRAR ratio was flat sequentially at 16.8%, but lower than 17.1% a year ago in March 2023. Compared to the September 2023 half, the data for March 2024 half shows that private banking CRAR fell by 20 bps to 17.8%  sequentially, while there was a sequential rise in the capital adequacy of PSBs from by 30 bps from 15.2% to 15.5%. While credit growth is strong, the PSBs also saw frenetic growth in profits in the second half.

HOW BANK PROFITABILITY PANNED OUT IN H2FY24

Let us turn to the earning and the profitability of Indian banks in H2FY24 ending March 2024. 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). Even as cost of deposits did not keep pace with cost of loans for a long time, that is changing, so one can expect pressure on the NIMs.

Let us start with the all-important net interest margins (NIMs). For H2FY24, the NIMs for the banking sector overall were stable at 3.6%, which is still a very healthy number. The net interest margins of PSBs were stable at 3.1% for the third sequential half year in a row. However, the private sector banks, which saw their NIMs taper sharply from 4.4% to 4.0% in the September 2023 half, have now seen the NIMs bouncing back by 30 bps to 4.3%. The profit after tax (PAT) for the banking sector overall improved by 32.5% in the September March 2024 half, which is appreciable considering the sharp spike in operating costs. The cost of funds for banks has gone up marginally to 5.4% while the yield on assets for banks overall is flat at 8.5%. Private banks are enjoying a better yield-cost spread at this juncture.

Let us finally turn to capital return ratios for banks. For the March 2024 half, annualized ROE of the banking system as a whole improved by another 90 bps to 13.8%. The private banks saw ROE improving by 120 bps to 15.4% in the March 2024 half, on the better of better cost management. The ROE for PSBs was also up by 90 bps on a sequential basis at 13.2%. In short, the growth in the ROE of private and public sector banks has been very robust in the April 2024 half. What about return on assets (ROA)? The ROA for the banking system improved by 10 bps to 1.3% in the March 2024 half. PSBs witnessed ROA flat at 0.9% on a sequential basis, while the private banks saw ROA improving by 10 bps to 1.8%. This is one area where the private banks lead the PSBs by a margin.

The last major takeaway from the FSR was that banks have also displayed substantial resilience to stress. The scheduled commercial banks are well capitalized to handle macroeconomic shocks; both in a medium stress and extreme stress scenario. This is true of the impact of extreme stress on profitability and GNPAs too!