Global Outlook

Sluggish credit growth may make the Banking sector unattractive

Contributed by Nirmal Bang

By Nirmal Bang

The entire world may want to congratulate India and China for their knee-jerk walk out of the financial slowdown. Double digit growth in India’s index of industrial production (IIP) for two consecutive months, rebound in gross domestic production (GDP) and reports of rising exports are all positive indicators of the Indian economy getting on a firm footing.

But there are still some pain points in the economy. According to the latest data released by the Reserve Bank of India, bank credit for the fortnight ended 1st Jan ’10, grew by 13.7% on an annual basis. The corresponding growth last year was higher at 23.8%. It is certainly not a good indicator for the economy at large.

If one looks at the year-to-date credit growth, which is a petty 9%, it’s a clear sign of sluggishness. Even at the peak of the crisis, the off take fell to around 13% last year. The second half of the financial year, traditionally, witnesses higher credit off-takes and with positives like burgeoning IIP and positive GDP expectations, the situation would keep improving from here, feel bankers and analysts.

But for India, the world’s second fastest growing economy, sluggishness in credit growth is definitely a cause of concern. According to an economist the weak credit growth is a major concern for recovery. With the onset of the global financial meltdown, mutual funds and non-bank corporates sought finance from banks. This propelled credit growth to around 30% in November ’08.

However, these flows reduced towards the end of 2008 and beginning of 2009, pulling credit growth down to less than 20% by February. Base effects could become increasingly favourable for credit over the next two months, says the economist.

So, is banking a good sector to bet on or is it the other way round? Banking continues to remain an attractive sector. But, recent quarterly results of large banks continue to highlight the sluggish trend. ICICI Bank, once considered India’s largest retail lender, reported an annual 13.4% decline in its bottom line for the quarter ended December ’09.

While its net interest grew by an annual 3.4%, the non-interest income for the quarter fell by an annual 33.5%. When Chanda Kochhar took over the reins of the bank from KV Kamath in 2009, she had clearly mentioned that degrowth was the strategy ahead then.

A quick dip into financial history reminds us of the words of former RBI Deputy Governor Rakesh Mohan. In the period of industrial slowdown, 1998 to 2002, annual growth in non-food credit had slowed to around 14.5%. This prompted Mohan to comment upon the situation as “lazy banking”.

Soon, during 2002-03 to 2005-06, credit growth accelerated significantly to 28.8%, where most of the credit expansion had been fuelled by an increase in retail credit – a stunning 46% growth between 2002-03 and 2005-06.

The point is not to blame large public or private bankers who have been aggressive in the retail lending space. A simple reason – Axis and HDFC Bank have posted better results in the latest quarter. For Axis Bank, advances grew by an annual 12.5%, which included 21% annual growth in retail lending, while corporate loans grew by an annual rate of 7.4%. Similarly, for HDFC Bank, advances recorded an annual 21% growth in the quarter ended December ’09.

So, where is value buying in the banking sector? Smaller banks, mainly private, currently provide a smart opportunity at this time. On A larger note, since the economy is now out of woods, the RBI may have to open up the banking sector sooner or later.

Currently, the RBI maintains that in the light of the global financial crisis, it has postponed its plans to open the sector for foreign banks till an appropriate time. “Consolidation in banking is no more a dead thought,” says a leading consultant who believes that smaller private banks would see the first wave of consolidation as it comes.

On an individual note, there are a few small private banks that opted to act during the last few months when the sector gave a pause to lending. Bank of Rajasthan, which caters to over two million customers through its network of 463 branches, took on an interesting journey since July ’09. The bank then tied up with Mahindra & Mahindra to help farmers in Rajasthan to obtain loans for tractors as well as farm equipment at lower interest rate and zero processing fees.

Towards the end of August last year, Bank of Rajasthan entered into a strategic national tie-up with Bajaj Auto to offer loans to two-wheeler customers at cheaper rates and lower fees.

A similar tie-up was struck with Hero Honda Motors in early September. And within a week‘s time, the bank tied up with Hyundai Motors to offer sweeter deals to its retail borrowers. And this was not restricted to auto financing alone.

Like bigger banks, scouting home loan borrowers, the bank also brought out attractive offers on home loan interest rates. “There is a well spelt strategy in these synchronized moves,” says a senior public sector banker. For smaller banks, it’s not easy to go out and play the market share game owing to limitations of their size and scale; he explains adding that these moves definitely help them strengthen their position in the niches.

Lakshmi Vilas Bank, with two-third of its branches located in Tamil Nadu, saw deposits and advances grow at an annualized 19% and 21% between 2006 and 2009. While this growth is lower than the industry average, it gives comfort of conservative growth ambitions.

Given that net profits grew by 33% annually between 2006 and 2009 just adds more comfort. In fact, the bank has made the most out of the lull with better-thanindustry growth in advances in the current fiscal. The bank has trebled its net profits on a low base in the first half of the year, with improving net interest margins and higher credit off take.

With 202 branches, City Union Bank is one of India’s efficient banks. Since its operations are primarily concentrated in Southern India, the bank has consistently reported net interest margin (NIM) in excess of 3% in the last nine financial years.

For quarter ended September ’09, latest results available, City Union Bank managed to grow its loan book at 19% annually and also increased its net profit by 21% in six months ending September.

The Kerala-headquartered Federal Bank, with 641 branches under its fold, is another shining star among the small private banks’ space. Just a couple of weeks ago the bank was having discussions to acquire south-based Catholic Syrian Bank. But the deal did not fructify. However, now IDBI Bank is all prepared to acquire the Federal Bank and it has already finished its due diligence for the initiative.

In a nutshell, it makes sense to jump out for small fishes and see them grow. It’s your chance to chase them with a strategy, just as they have some strategies of their own.