Indian banks are now healthy, but still not cautious

By Andy Mukherjee

India’s banks spent most of the last 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 may 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, according to economists at Australia & New Zealand Banking Group Ltd. Just last month, New Delhi-based developer DLF Ltd sold $1 billion worth of million-dollar homes on the outskirts of the national capital in 72 hours. A one-year, 29 per cent jump in credit-card debt has made even the Reserve Bank of India, the regulator, 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.

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Yet, HDFC Bank Ltd and ICICI Bank Ltd, two of the country's largest lenders by market value, slashed their loss provisions for the financial year that ended in March by 23 per cent. The money ICICI has set aside cumulatively is now Rs 900 crore ($122 million) less than a year ago. That isn’t a problem yet, because gross non-performing assets have declined at a faster pace of Rs 2,700 crore. However, there’s nothing to suggest that they won’t rise again.

With the incremental credit-to-deposit ratio running at 111 per cent, Indian banks will have to pay more to savers — sacrificing some part of their high profitability. Although even this won’t 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,” according to Rebecca Tan, a senior analyst at Moody’s Investors Service. Problems may 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,” she said in a Bloomberg TV interview last month.

Since then, an unexpected pause in monetary tightening by the central bank has provided some reprieve, though the effects of a cumulative 250-basis-point increase in rates will be felt for some more time. High interest rates may be particularly worrisome for the risk-chasing behavior of non-bank financial institutions, or NBFIs, which don’t 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 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 aren’t exactly oblivious to the danger. Excluding retail and rural lending, ICICI now has only 0.8 per cent of its loan portfolio exposed to riskier firms rated BB or below. Two years ago, the figure was as high as 3.6 per cent. Axis Bank Ltd, the fifth-largest lender, didn’t have to utilise its Covid-19-related loss cushion in the March quarter. As a result, even with a 64 per cent drop in full-year provisions, it still has gross bad loans covered to the extent of 145 per cent. However, all of this is backward looking. The retail loan book for both HDFC Bank and ICICI has grown by Rs 1 lakh crore apiece over the past 12 months. Axis saw almost a Rs 90,000 crore increase, while Bajaj Finance Ltd, a specialist nonbank lender to consumers and small firms, expanded its assets by about Rs 50,000 crore. 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. And yet, Bajaj, too, has cut back on loss provisions by 34 per cent.

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 $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. 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 per cent annually is simply not trying hard enough.

But consumer demand is being led by a small pocket of affluence. The 6.5 per cent growth in gross domestic product that the 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 $245 billion software-export industry gloomy. 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 degrees Celsius (41 degrees Fahrenheit) in many parts of the country. Heat waves could damage crops and cause power shortages.

It’s time lenders behaved a little more prudently. The aggregate bad-loan ratio of 4.41 per cent 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,” RBI Governor Shaktikanta Das said in a web-streamed address 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 couldn’t expect even 1 per cent return on assets from a vast swathe of the Indian banking industry. Now that things have changed, 2 per cent should be good enough for current 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 may not be at a risk of abrupt reversal. But since it’s a cycle, at some point it will turn.