Money for nothing

Tags: Banking

Rising bad debt, low credit demand leave no room for crazy banking

Money for nothing
The banking industry is passing through slack days reminiscent of the early years of the millennium. Credit growth has hit the decade’s low on the back of drought in demand from companies, which are staring at a yawning output gap and weakening pricing power.

Buffeted between high cost of money and inability to pass on rising costs to the consumer, corporate India is slow not only in contracting new bank credit for capital expenditure, but has, for most parts, also put the production machinery on a lower gear, thus obviating the need to run to banks for large working capital loans.

In consequence, bank credit growth has dropped to the lowest in a decade. Annual credit growth last month was 15.4 per cent, just a whisker ahead of the 2001-02 growth of 15.3 per cent -- both a far cry from the peak of over 30 per cent seen between 2005 and 2008.

In a year-to-date timeframe credit growth was only 3.7 per cent, marking the decade’s bottom. In the corresponding timeframe last year, growth was higher at 5.2 per cent.

High cost of money is, of course, one reason. Look closely and you find sectors like infrastructure, power, roads and telecommunications are not rushing to get loans for reasons that go beyond high interest rates. Most projects in these sectors are in a limbo in absence of key clearances, mainly for land and environment.

Infrastructure used to be a big debtor till 2009. More than a quarter of incremental credit used to go to it. Today it sits tight: delays in policy, environmental clearances, land acquisitions and scores of other permissions have meant that projects have no immediate need for loans.

A former RBI governor, Y V Reddy, put the situation in perspective in a paper presented to the Bank for International Settlements in June. He said: “In 2001-02 the problem was one of slow credit growth. We described it as lazy banking and tried to encourage banks to improve credit growth with regulatory and monetary policy initiatives. Soon the lazy bankers became crazy bankers. Excess credit seems to have been preceded by slow growth in credit. The problem is to identify the point at which credit growth becomes excessive or too rapid.”

Today the gargantuan portfolio of bad debt leaves no scope for crazy banking.

In an exclusive interview with the Press Trust of India, finance minister P Chidambaram this past fortnight suggested that banks should lend aggressively and restructure loans of stressed sectors to revive the investment climate. “A bank cannot do business only when the times are good, banks must also do business when times are difficult,” he said.

Making a case for debt restructuring, he said: “When times are difficult, accounts will become NPAs, but then RBI allows NPA accounts to be restructured. This has been done in the past and it is being done in various countries. You restructure the account, allow more time for the loans to be serviced and allow the industry to pick itself up and go forward,” he said. “These are difficult times, banks must handhold industries,” he said.

On their part, banks are desperately trying to market credit to top-rated companies. But borrowers are few and far between, most shying away or taking money only to bridge temporary mismatches of 10 to 15 days. For everything else, companies are making do with internal accruals.

Bankers talk of how some of them personally try to sell credit to bankable clients but are mostly politely told “thanks, no thanks.” Companies have no need for credit in a decelerating economy.

GDP growth slowed to 5.3 per cent in the second quarter from 5.5 per cent in the preceding quarter. Plus, government finances are in a shambles: fiscal deficit is set to cross the budgeted 5.1 per cent and touch 5.5 per cent. This will keep at bay foreign investors who may have otherwise come in and offered a crutch to the economy.

In the aftermath of the 2008 global slowdown, India was rather smug that our banking system had been able to weather the global crisis. It was claimed that our banking industry was on a solid footing, unlike some global banks. No Indian bank went bust, it was pointed out.

Those smug smiles have vanished. Global growth has slowed to two per cent; Indian growth too is crawling at 5.5 per cent. It has now dawned that India’s economy is more closely interlinked with the global economies than was thought before.

It is an acknowledgement that comes the hard way when cheap steel from abroad plays havoc with Indian steel makers who sit on mountains of unsold inventory.

With their markets shrinking both at home and abroad no one in his right mind will spend money on setting up new facilities or expanding existing factories.

Excess capacities, especially in steel in the UK and Ukraine, and cheaper goods from China hurt India. You cannot really blame Indian companies, and therefore banks, for crying out loud.

Pratip Chaudhuri, CMD of State Bank of India (SBI), sums up thus: “Companies are not asking for credit as their margins have shrunk. There is no demand even for working capital loans.”

Companies would rather raise money in the corporate debt market but not from banks. “We at SBI are sitting on excess liquidity of Rs 75,000 crore. If any bank has seen growth in its advances, the chances are low-rated companies are accessing this credit,” he said.

In the second quarter review of monetary policy, RBI admitted credit growth had ebbed because of the slowdown in investment demand, especially in infrastructure, and lower absorption of credit by industry.

One unaffected component of lending is working capital credit to oil companies and power generating companies. Oil firms have no option. A depreciating rupee and appreciating crude oil prices have combined to increase the companies’ requirement of working capital to pay for imports. Ditto is the case of fertiliser and power generating companies reliant on imported coal and/or gas.

In any case, bankers say, lending in these sectors is already close to the prescribed exposure limits. Sector exposures are capped at 15 per cent of a bank’s capital funds. Oil companies are an exception where the cap is 20 per cent.

Bankers say credit restructuring has further stressed the sector exposure limit in infrastructure. In other words, banks may have already reached the cap on lending to single counter-parties in infrastructure projects.

Effect of high interest

The industry has been asking for interest rates cuts for a long time. Its argument is that all the ills of the Indian economy stem from high interest rates. The fact is many of the problems arise because the reforms push from the government has not come, giving foreign and domestic investors reason to be skeptical about India’s growth.

Siddhartha Roy, the Tata group’s economic advisor, says no company will borrow at such high rates for capex. Plus, banks in general have turned cautious. The slowing growth in the economy is a factor, he admits.

RBI does not fully buy industry’s argument. RBI governor D Subbarao is on record that interest rate is only one of many factors in an investment decision.

“Investment decisions take into account not just the current rate of interest but interest rate over several cycles. What proportion is interest cost in total cost? Just about three per cent,” he had said in a speech in June.

Historical data show an inverse relation between real lending interest rates and investment activity. Real interest rates today are lower than they were in the pre-crisis years when investment boomed. Investment today is sluggish, suggesting that factors other than interest are at play in the investment slowdown.

From ‘crazy’ to ‘sane’ banking

In the policy review on October 30, RBI increased the provisioning for restructured loans from two per cent to 2.75 per cent. This followed the restructuring book of banks expanding to 5.7 per cent of their total advances.

In another dictat the loan-to-value ratio in home loans was stipulated at 60 per cent, i.e., banks could fund only up to 60 per cent of the cost of a house. The earlier practice was to fund up to 90 per cent. Naturally, unless the number of loans itself multiplied, the total advances would tend to be lower than before.

One point often missed (or not talked about with as much emphasis as the demands for rate cuts) is that the 30 per cent credit growth between 2005 and 2008 came at higher rates of interest.

Then there was confidence in the economy. India was poised to grow at double digits and companies drew up plans for massive capex expansions. “The optimism is missing now,” said a banker.

Private banks had unleashed retail lending at a feverish pitch. This led to a scenario wherein people spent huge amount on purchases with credit cards but willfully defaulted on repayments. One day the bad loans came home to roost for banks, forcing them to curb their ‘crazy’ banking ways and get back to ‘sane’ banking. Lending was again done with caution and only to worthy borrowers at reasonable interest.

The caution was later to be applied to corporate borrowers too. Capex expansions were taking place in all sectors to meet demands of an expanding economy growing at over 8.5 per cent. Then out of the blue came the global financial crisis, dashing hopes of double-digit growth rates in India.

Caution is the key, warned K C Chakrabarty, RBI deputy governor, too, in the context of infrastructure projects. He recently told an Assocham meeting that banks must hone their credit appraisal, monitoring and risk management skills in view of the long gestation of infrastructure projects.

Much of bank credit offtake is dependent on corporate needs. Those needs are not going to arise in a hurry, says Emkay Global Financial Services in a report.

The report says that it is difficult to expect corporate investments to revive on the back of small rate cuts, given the decline in asset utilisation of companies amid declining productivity of capital and higher leverage. If investments are a key driver of credit, Emkay expects it to start strengthening after a sequence of bottoming out of variables. The variable, in that order, are profits growth, margins, sales growth, investments and then credit growth. “Clearly, the bottom for investment and credit growth cycle is still far away,” says the report.

An inescapable conclusion from that is that till then bankers catering to companies can do little but twiddle their thumbs.

The infrastructure lead

Bank credit has been led by infrastructure for a while. At one point the sector accounted for over 35 per cent of all bank credit in India; this has now come down to 17 per cent.

Public sector banks control nearly 75 per cent of all bank credit; most of them are focused on infrastructure. Coal linkages for power projects are still absent; land problems still dog roads and most development projects. Bank credit growth can only decelerate.

Credit growth was not more or less on tract even in the immediate aftermath of the 2008 global crisis. That’s because of the 3G auctions that saw banks handing out credit worth over Rs 1,00,000 crore.

That buoyancy went out of the window after the 2G scam broke. Banks became cautions in lending to telecom companies. Yet, between April 2007 and March 2011 infrastructure credit grew by 38 per cent annually. According to Chakrabarty of RBI, credit to infrastructure still accounts for almost a third of bank credit to industry.

From all indications infrastructure will continue to get a big chunk of industry credit for a long time to come, as the country will continue to need efficient public transport, roads, public utilities, housing, educational institutions, ports and airports. The need for large investments will continue; so will the need for bank credit.

A McKinsey estimate suggests that each year we may have to build about 700 to 900 million square metre of home and commercial space, 350 to 400 km of metro rail systems and subways and 19,000 to 25000 km of roads.

This is a massive task -- and, equally, a massive opportunity for banks. The 12th plan approach paper estimates that infrastructure investment will need to increase from eight per cent of GDP in 2011-12 to 10 per cent in 2016-17. This entails an investment of over Rs 45,00,000 crore ($1 trillion) in infrastructure during the plan period. This surely will keep banks busy.

What’s for store in future

Not all hope is lost. There is a silver lining: there is some credit drawdown for capacity expansions in the current quarter. The annual credit growth as on November 2 was 16.30 per cent, a slight improvement on the RBI projection for non-food credit growth at 16 per cent for whole of 2012-13.

Banks have again become aggressive on credit cards, vehicle loans, personal loans and agriculture, though they still remain cautions about who to lend to in industry. They carefully choose and concentrate on small retail loans rather than chunky advances to a single corporate account. At the end of September, bank credit to industry saw a 15.6 per cent growth from a year ago when the corresponding growth was 22.9 per cent.

Over the year credit card advances grew the fastest (21.9 per cent), far better than the 2.2 per cent growth recorded a year ago.

Over the past four quarters banks have been focusing on retail loan growth by cutting interest rates and processing fees and pushing promotional schemes.

There is a spurt in vehicle loans, Rs 1,02,700 crore of which have been lent out; this is 22.2 per cent higher than in the previous year when growth was (19.3 per cent).

Chanda Kochhar, ICICI Bank CEO and MD, said last month after announcing the results: “Working capital loans and retail credit growth will be the mainstay of credit for the bank in the coming quarters until investments begin into projects.”

Half the Rs 6,670 crore incremental credit offered by the bank in the second quarter was retail loans.

Conventional wisdom is GDP to grow by one per cent and credit has to grow by at least 2.5 per cent. This underlines banks’ abject need of capital so as to remaining the business of lending. A bank official who did not want to be identified said, “If the obsession with fiscal deficit continues, then capitalisation of the banking sector cannot come in a hurry.”

For now, the problem is not of shortage of lendable funds but of finding enough creditworthy borrowers.

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