The alarming state of Public Sector Banks-Part 1

After the completion of mega bank mergers announced by the Finance Minister in August 2019, the present count of 27 public sector banks (PSU banks) will come down to 12. The share of the total business of banking sector in India held by the public sector banks continued to grow through the 1980s and 90s, and PSU banks accounted for 90% of the total banking sector's business. Their decline started during the late 90s, after the emergence of private sector banks. As of 31 March 2019, the total amount of deposits in the Indian banking system was Rs 125.6 trillion, of which public sector banks had 63.1% of these deposits and private sector banks held 28.7%. As of 31 March 2019, the total amount of loans given out by Indian banks was Rs 98.2 trillion, of which public sector banks had a market share of 58.8%, while private banks had 33.6% share. This is the declining share of PSU banks in the outstanding deposits and loans of banking sector.

If we will look at loans given out and deposits raised during the last financial year, the situation is alarming. In FY 2018-19, private banks gave a total of Rs 7.3 trillion in loans, while public sector banks gave only Rs 2.3 trillion in loans. In FY 2018-2019, private banks raised deposits worth Rs 7.1 trillion, while public sector banks raised only Rs 2.7 trillion.

As many as 11 PSU banks were placed under RBI's prompt corrective action (PCA) framework, from which a few banks have come out. Placing a bank under the PCA framework puts restrictions on lending, hiring and expanding branches by the concerned bank. Government has infused a total of about Rs 2.5 lakh crore of capital into PSU banks during the last three years. In FY 2017-18, the Government of India had injected Rs 88,000 crore in PSU banks, including the budgetary support portion and bonds. In FY 2017-18, the government had infused nearly Rs 1,06,000 crore in PSU banks. In the budget for 2019-20, the government has outlined a Rs 70,000 crore for PSU banks recapitalisation.

The gross non-performing assets (GNPAs) of public sector banks have declined by Rs 89,189 crore from a peak of more than Rs 8.95 lakh crore in March 2018 to over Rs 8.06 lakh crore in March 2019, as per RBI data. As of March 31, 2018, some estimates suggest that the total volume of gross NPAs in the economy stands at Rs 10.35 lakh crore. So about 87% of all the NPAs are from loans of public sector banks, even though PSU banks market share in total loans is only 58%.

More than half of the public sector banks are on weak fundamentals. RBI has not only placed 11 weak PSU banks under PCA framework, but has also actively considered some more banks. PCA framework is meant to be a tool of dis-empowering the weak banks. In that sense, PCA framework worked well to refrain these weak public sector banks from undertaking risky driving any further. But in the process, weak public sector banks have left the steering wheel altogether and started sitting in the backseat. They have refrained from their core activity of lending. Some weak banks have also sold or recalled some of their existing standard loans, in order to shore up their capital adequacy. This has led to the shrinking of their loan books and also increased the share of bad loans in their total loan portfolios. Some of the Special Mention Account-2 (SMA-2) exposures of these weak banks have also turned into NPAs, which in turn increased their Gross NPAs and provisioning requirements. Shrinking loan books has significantly reduced their credit to deposit ratio (CD ratio). Declining CD ratio and increasing provisions have pushed up their cost to income ratio, completing the vicious cycle.

During the last 5 years period between FY'15 and FY'19, weak public sector banks' profitability, solvency and adequacy ratios have deteriorated significantly.

The general assessment of analysts that the NPA cycle in the public sector banks has almost bottomed- out is based, inter alia, on the premise that the economy has bottomed out. Hopefully the economy may recover soon and the weak public sector banks may see the light at the end of tunnel.

State Bank of India

The roots of the State Bank of India lie in the first decade of the 19th century when the Bank of Bengal was established on 2 June 1806. The Bank of Bengal was one of three Presidency banks, the other two being the Bank of Bombay and the Bank of Madras. The three Presidency banks amalgamated on 27 January 1921, and the re-organised banking entity took its name as Imperial Bank of India. Pursuant to the provisions of the State Bank of India Act of 1955, RBI acquired a controlling interest in the Imperial Bank of India. On 1 July 1955, the Imperial Bank of India became the State Bank of India. In 2008, Government of India acquired the RBI's stake in SBI, so as to remove any conflict of interest.

During the 5 year period between FY'15 to FY'19, SBI has added almost one lakh crore of rupees to its reserves. Its reserves have gone up from Rs 1.27 lakh crore to Rs 2.20 lakh crore during the 5 year period. Only a third of incremental reserves were generated by profits earned. Balance two-third of incremental reserves added were through divestments in its subsidiaries. During the last 5 year period, SBI's deposits have almost doubled from Rs 15.76 lakh crore to 29.11 lakh crore. But its advances have gone up by only 68%, from Rs 13 lakh crore in FY'15 to Rs 21.85 lakh crore in FY'19. As a result, the bank's credit to deposit ratio (CD ratio) has declined from 82% in FY'15 to 75% in FY'19. But provisioning for NPAs has taken a toll on its profitability ratios. SBI has made provisions of about Rs 2.1 lakh crore during the last 5 years. As a result, SBI's return on assets has declined from 0.68% to 0.02%. SBI's return on equity has declined from 11.17% to 0.48% between FY'15 and FY'19.

SBI's tier-1 plus tier-2 capital adequacy (Basel- III) stands at 12.72% as at March 2019, against RBI's mandatory requirement of 10.5%. Its tier-1 plus tier-2 capital adequacy has improved marginally from 12% in FY'15 to 12.72% in FY'19. Its Net NPAs stand at 3.01% in FY'19, up from 2.12% in FY'15. There is some improvement in SBI's asset quality during the last two quarters of current financial year. Its gross non-performing assets (GNPA) declined to 7.19 per cent as on September 30, 2019, down from 9.95 per cent a year ago.

Though SBI is sound on capital adequacy and growth front, it is relatively weak on asset quality front.

Bank of Baroda

Bank of Barda (BoB ) is the second largest public sector bank after SBI. After completion of the mega bank mergers, BoB will be relegated to 3rd position and PNB will climb to 2nd position. The bank was founded by the Maharaja of Baroda, Maharaja Sayajirao Gaekwad- III in 1908. The bank, along with 13 other major commercial banks, was nationalised on 19 July 1969, by the Government of India.

BoB's credit to deposit ratio (CD ratio) improved marginally from 70% in FY'15 to 73% in FY'19. Its tier-1 plus tier-2 capital adequacy (BASEL- III) has improved marginally from 12.60% in FY'15 to 13.42% in FY'19. But provisioning for NPAs has taken a toll on its profitability ratios. BoB has made provisions of about Rs 0.56 lakh crore during the last 5 years. As a result, BoB's return on assets has declined from 0.49% to 0.06%. BoB's return on equity has declined from 9.21% to 1.18% between FY'15 and FY'19. BoB's cost to income ratio has increased from 29.96% in FY'15 to 43.41% in FY'19.

Bank of Baroda's gross non-performing assets were at Rs 482 billion or about 10% of advances at the end of fiscal year 2019. The gross NPA value in the previous fiscal year of 2018 was even higher at Rs 564 billion. BoB's gross NPAs were about 5.5% in FY'16 which have gone up to 10% in FY'19.

BoB's business is almost stagnant during the last 5 years. Its deposits have grown by a mere 3% in the five years, up from Rs 6.17 lakh crore in FY'15 to Rs 6.38 lakh crore in FY'19. Its advances have grown by a modest 9% in the five years, up from Rs 4.28 lakh crore in FY'15 to Rs 4.68 lakh crore in FY'19.

Though BoB is sound on capital adequacy, its business is stagnant and asset quality is a concern.

Punjab National Bank

Punjab National Bank (PNB ) is the third largest public sector bank in India, after SBI and Bank of Baroda. Punjab National Bank was originally established on April 12, 1895, in Lahore under the leadership of Lala Lajpat Rai as a part of the Swadeshi movement.

The bank has a large work force of 2,700 people working at present in its stressed asset management vertical, indicating the enormity of the problem of stressed assets in the bank. Diamond trader Nirav Modi had defrauded the bank to the tune of Rs 11,300 crore.

Capital constraint continues to be a major drag for the growth trajectory of PNB, with tier-1 capital adequacy ratio of 6.35% at the end of June'19 quarter. Regulatory minimum requirement for tier-1 capital ratio is 8% by the end of March 2020. Growth remained a major issue for PNB with global loan growth at 3.2% and domestic loan growth at 7.3% YoYin June'19 quarter.

Tier-1 plus Tier-2 capital adequacy ratio of 11.52% in FY'14 has come down significantly to 9.73% in FY'19. Net NPAs during the same period have gone up from 2.85% to 6.56%. In effect its capital adequacy has eroded by 5.5% during the last 5 years.

Almost a fifth of the loan book of PNB is non-performing assets (NPAs). PNB's gross NPAs have shot up by more than 3 fold during the last 6 years, from 5.25% at end of FY'14 to 16.5% in June '19 quarter. PNB made total provisions (against NPAs) of near about Rs 98,000 crore during the last 5 years period since FY'15. Even after making such large provisions, PNB's provision coverage ratio (PCR) is at 61% at end of June'19 quarter. This will necessitate further provisions to be made in the coming years.

PNB's profitability ratios have also steadily declined during the last 5 years. Its return on assets ratio has declined from 0.50% to (minus) 1.25% between FY'15 and FY'19. PNB's return on equity ratio has declined from 8.12% to (minus) 24.20% between FY'15 and FY'19.

The bank's credit to deposit ratio (CD ratio) has declined from 76.60% in FY'15 to 68.14% in FY'19.The bank's cost to income ratio has gone up from 37% to 58% during the last 5 year period. In the last two financial years of FY'18 and FY'19, PNB has incurred large losses of Rs 12,282 and Rs 9,975 crore respectively.

At end of FY'19, PNB has a net worth of Rs 44,787 crore against which it has Net NPAs of about Rs 30,000 crore, which are still to be provided for. So PNB has an adjusted net worth of about Rs 14,787 crore at end of FY'19, after reducing the Rs 30,000 crore of Net NPA to be provided for. Further, PNB has a large "deferred tax asset" of Rs 18,631 crore at the end of FY'19. A deferred tax asset is a mere book asset, which can be realised only when the bank makes sufficient profits. PNB is operating on a thin line. In FY'14, it had total deposits of Rs 4,51,397 crore against a net worth of 35,895 crore (adjusted net worth of Rs 25,945 crore). In FY'19, it has total deposits of Rs 6,76,030 crore against a net worth of 44,787 crore (adjusted net worth of Rs 14,787 crore).

Even though PNB is facing serious capital constraints, bank's management is saying that the bank is not seeking any additional capital infusion from the government. Capital adequacy of PNB needs to be strengthened either through fresh infusion of equity by the government or by an issue of FPO/QIP and/or through dilution of bank's holdings in its subsidiaries. The bank's capital base needs to bestrengthened before the merger process of Oriental Bank of Commerce and United Bank of India with PNB is completed. After merger, PNB will become the second largest public sector bank in the country. Without infusion of additional capital, PNB may turn out to be a "too big and too fragile" a bank.