Are Private Banks Safe Investment Bets?

Thu, 19 May Pre-Open

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The bloating bad loans in Indian banks and their provisioning is something we all are aware of. The issue has grabbed headlines every now and then. But what is surprising is that private banks considered to be relatively insulated from the NPA crisis are now beginning to crack under the pressure of slippages.

This is reflected in the ICICI Bank's performance in the March 2016 quarter results. The bank reported a 76% YoY drop in its net profit for the quarter. The dip in profitability was primarily on the back of a substantial increase in provisions (subscription required). The earnings of another large private sector bank, Axis Bank were hit by jump in bad loans and consequent higher provisioning.

The sudden increase in the bad loans of private sector banks over the last 2-3 years seems to defy logic. At the end of December 2013, stressed advances of private sector banks were a mere 4.13% of total advances as per P J Nayak Committee report. But the stressed advance ratio of public sector banks were already at alarming levels of over 12%.

But a study by Livemint shows that the highly leveraged borrowers roughly formed 18-19% of overall assets for both public sector and private sector banks as of December 2013. Therefore with no marked difference in the portfolio of stressed borrowers at that time, private sector banks had been apparently concealing the stress in their books.

The reason for understating bad loans may be to protect the bank's profits from getting hit by higher provisions. This is because the incentive structure of the top management for private banks is invariably linked to its profitability. Moreover, compensation given to senior management in the form of stock options is also dependent on the stock price. This in turn has given rise to the practice of evergreening of loans by a bank's management.

What this means is that private sector banks can be equally exposed to bad loan risk as public sector banks. The above analysis clearly shows that it is not just public sector but also private sector banks that the Reserve Bank of India (RBI) needs to be worried about. For the latter certainly have been as lax about credit quality and loan recovery efforts as the former. Hence, as an investor one needs to be selective about the choice of private sector banks too.

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