Like on April 8th, the Nifty bank index has fallen by more than 38%, while reference indices have fallen by 25%, YTD. The same is true for global markets, as the US Dow Jones bank index declined by 37%, compared to the S&P 500 decline of approximately 14% in the same period. The MSCI World Bank Index has also fallen much more than the MSCI World Index, showing that the banking sector is hit more than other sectors by lockdowns around the world. Banks are a mirror of the state of the economy and the expected huge economic impact is bound to have an impact on bank shares. The damage in India was so great that blue chips and strong balance giants such as HDFC Bank and Kotak Mahindra bank even fell by 40% and 35%, YTD, respectively.
The uncertainty in Investor’s mind about the banking sector can be split into two stages. The first is related to liquidity issues, after the IL&FS and DHFL crises, which slowed down credit growth and also the uncertainty surrounding the Yes Bank saga. The second phase and the more valid fear is that of the impact of the current Covid-19 closure in India.
The uncertainty following the Yes Bank issue was much more related to doubts and speculation that the banks could go bankrupt. But the RBI has more or less dispelled fears of this with a planned rescue package for the bank. Some banks experienced outflows of deposits because of this problem, as well as alleged governance problems, and as a result their share prices were affected. But during this time, larger banks with strong balance sheets and deposit franchises were largely unaffected by this. Exposure to the telecom companies, influenced by the AGR ruling, also had an impact on prices.
But a much wider and longer effect on the banking sector is the impact of the virus lock on banks. The lockdown has exacerbated fears of bad loans, rising NPAs and bleak outlook for credit growth for banks. Banks will suffer from their credit exposure to the various sectors and to individuals in the associated sectors through personal loans. The lockdown has closed tourism and nonessential trade, closed offices, hotels, restaurants and shopping centers, meaning commercial real estate has also been affected. The high risk areas are Auto, Microfinance, Agriculture, MSMEs and Real Estate along with unsecured personal loans, credit cards and auto finance. Banks expect a decrease in direct debits and, at the same time, a greater demand for working capital from borrowers. The credit rating agencies have a negative outlook for the entire banking sector due to the disruptions caused by the outbreak.
If you look at the sectoral credit stake data from 39 planned commercial banks, as published monthly by the RBI, that accounts for 90% of total non-food credit.
As of February 2020, total non-food credit grew by just 7.3% to Rs 89 trillion year-over-year, compared to 13.2% growth a year ago. This slowed growth was mainly due to the lower growth of industrial credit and also to the services sector. Banks were already faltering due to slowed credit growth. But even for the credit provided, banks have lent more to sectors that seem most vulnerable to the lockdown imposed by India compared to a year ago. Loans to tourism rose 16.9% and commercial real estate rose 15.1% year-on-year, while total credit growth for the year actually fell below last year’s rate. While these sectors make up a small percentage of total credit, (in absolute terms commercial lending is only 2.6% of total credit and tourism is only 0.5% of total credit), banks will be concerned about their larger exposure to these highly impacted sectors and asset quality.
While the rate of credit growth to NBFCs has slowed, as a percentage of total credit, NBFC’s exposure to bank loans has risen from 6.9% a year ago to 7.9%. Some NBFCs were already struggling with liquidity issues and this lockdown will only make things worse for them. After large corporate and residential loans, the NBFC sector is responsible for the largest percentage of bank loans.
As the offices are closed and the above sectors are among the largest job creators, this will have a cascading effect on personal income and the individual’s ability to repay personal loans. Personal loans accounted for 28% of the total credit. The deferral of RBI payments for loans has provided temporary relief, but it remains to be seen how soon the recovery will take place and the repayment capacity. Micro and small business loans (including credits to the manufacturing and services sector) accounted for 12% of total non-food credit and this sector is listed as one of the most vulnerable during this lockdown period.
The outbreak and subsequent shutdown will certainly have an economic impact on companies, individuals and will undoubtedly affect all sectors of the economy. The slowdown in economic activity will undoubtedly have consequences for the debt service of many borrowers. The moratorium on loans announced by the RBI allows banks to postpone NPA recognition. But ultimately, the NPAs are expected to peak in the coming quarters.
The government may also have to make a capital contribution to PSBs. After about Rs. Having pumped 3.5 trillion to strengthen some banks’ balance sheets, banks were expected to tap capital markets for funds this year. In the current situation this looks challenging and the government may have to intervene despite the weak budgetary situation.
To compensate for sluggish credit growth, banks should also refrain from evergreening, which is the process of updating an overdue loan as current by issuing a new loan. They should also be vigilant against zombie companies, unable to cover the cost of debt service and possibly wanting to use cheap credit. The management comments from the past few weeks have taken note of the situation and are encouraging in that they understand the seriousness of the current scenario and have practical time periods and an action plan for the expected recovery when it occurs. The need for banking portfolios will become more apparent within a few months of the end of the suspension of payments period and the testing of borrowers’ repayment capacity. Banks have different positions in the sectors and some banks were already faltering under a bad credit hike before the impact of Covid-19. Once the dust settles, the better-managed banks, with low NPAs and good margins, will be back in the investor’s radar.