Credit boom, but where are the profits?
A. S. Ramasastri
N. K. Unnikrishnan
The Hindu Business Line, Nov. 29, 2005
GIVEN the upheaval that banks faced in 2004-05, both in terms of a substantial
increase in bank credit and the marginal rise in interest rates, the banking
sector's profitability ought to have improved. However, an analysis based on the
data in the Statistical Tables Relating to Banks in India 2004-05 published by the
Reserve Bank of India, reveals a different story.
To get an idea of bank profitability in the country, let us examine the numbers
against the barometer of return on assets. The majority of banks reported a
lower return on assets. Excluding the new entrants, and some old ones that
exited from banking business, only 15 out of 85 banks registered an increase in
return on assets as at the end of 2004-05 over 2003-04.
Of these, within the State Bank group, only one — State Bank of India —
marginally increased the return on assets. Of the 19 nationalised banks, only two
(Indian Overseas Bank and Punjab National Bank) were able to increase their
return on assets last year. The picture of private banks was worse, with just
three out of 27 banks reporting an increase in return on assets.
Two of the prominent private players in the retail loan market (HDFC Bank and
ICICI Bank) registered a higher return on assets in 2004-05 over 2003-04.
Centurion Bank, which was in the red in 2003-04, managed a turnaround and
reported the highest increase in return on assets among all the 85 banks. While
nine banks reported higher returns, foreign banks present a better picture (see
Table 1).
Thus, 60 out of 85 banks registered a decline in return on assets. Some of them,
of course, did worse than the others. Table 2 lists 21 banks with a more than
100-basis-point decline in return on assets during 2004-05 over 2003-04.
Prominent among them are State Bank of Saurashtra, Bank of Punjab, Catholic
Syrian Bank, J&K Bank and Lord Krishna Bank. The list has 11 players, all old
private sector banks.
The decline in the profitability of the banking sector is also captured through the
return on asset figure (Table 3). In 2003-04, 48 banks recorded a return on
assets of 1-2 per cent. This number, however, fell to 31 in 2004-05. The number
of banks with return on assets of 0-1 per cent was 19 in the preceding year,
which increased to 28 in 2004-05.
Further, there were seven banks with negative return during 2003-04, and the
number of banks in the red rose to 18 in 2004-05. Of these, nine are private
sector banks and eight foreign outfits. Moreover, while 12 banks had a return on
assets of more than 2 per cent in 2003-04, only eight notched up this figure in
2004-05.
Despite a reduction in the cost of deposits and of borrowings, the spread has
declined for all banks, partly due to reduced trading profits from investment
portfolios.
Thirty-nine banks increased their spread in 2004-05 over 2003-04. Of these,
four are from the State Bank group, 11 are nationalised outfits, 15 are from the
private sector and nine are foreign banks. Thus, banks that managed their
spread better are in a minority, in spite of a favourable atmosphere in terms of
cost of funds. However, four private and 13 foreign banks have higher noninterest income. None of the government-owned banks increased their noninterest income.
On the expenditure side, banks' wage bills have increased, in general. For
private and foreign banks, this increase could be partly due to the increase in
number of employees. For private banks, the number of employees increased to
92,618 in 2004-05 from 81,120 in 2003-04. HDFC Bank, ICICI Bank and UTI
Bank alone enrolled more than 9,000 new employees.
In the foreign banks, the number employed increased to 16,386 in 2004-05,
from 14,198 in 2003-04. Major employment generators among foreign banks are
ABN Amro, Citibank and HSBC; they accounted for more than 2,000 new
recruitments. The increase in the wage bills of private and foreign banks seem to
be due to their expansion plans. However, despite the marginal reduction in the
total number of employees, the wage bill of public sector banks increased last
year.
Irrespective of the reasons, banks, in general, found it difficult to cut operating
expenses. But cheap deposits seem to provide a level of comfort in the face of
increasing operating expenses. This indicates that banks have improved their
return on assets, achieving this through spread or non-interest income and not
necessarily by cutting intermediation costs.
To refine this point, let us contrast the behaviour of banks that recorded an
increase in return on assets and those that reported a substantial decline.
The first group, listed in Table 1, achieved positive returns on assets in trying
circumstances; let us call them `high performers'. The second group, listed in
Table 2, had a decline of more than 100 basis points in return on assets in 200405 over 2003-04; call them `low performers'.
What are the major factors that distinguish the two sets?
Table 4 presents the proportion of banks with an increase in the ratios in 200405 over 2003-04.
Among those that increased their return on assets, 60 per cent managed to have
higher spread, while among the banks with substantial decline in return on
assets, only 43 per cent managed their return on assets better than the
preceding year.
With regard to non-interest income as a percentage to total assets, among
"high" performers, 47 per cent improved their own performance in 2003-04,
while among "low" performers, only 23 per cent did better. The wage bill as a
percentage of the interest income increased for the majority of banks,
irrespective of the category.
Thus, at least in 2004-05, there was no difference between "high" and "low"
performers vis-à-vis wage bills.
However, the ability to raise operating expenses from non-interest income
(burden ratio) was better for the "high" performers than the "low" performers.
The cost of deposits has come down for a majority of banks, irrespective of the
categories. But the cost of borrowing increased for 43 per cent of the "low"
performers, which was much lower (at 27 per cent) for "high" performers.
Thus, major distinguishing features between "high" and "low" performers are:
 Better management of interest margin;
 Better management of non-interest income;
 Ability to meet operating expenses from non-interest income rather than from
interest income, and
 Cheaper cost of borrowing.
Finally, in their effort to prop up sagging bottomlines, are banks taking higher
risk? If data on secured advances as a proportion of total advances are any
indication, the majority of banks extended more unsecured advances in 2004-05
over 2003-04. Out of 85 banks, 52 increased their unsecured advances last year.
Further, 73 per cent of the "high" performers reduced their secured advances
while the corresponding number is only 43 per cent for the "low" performers,
implying that the former achieved higher return by taking higher risk.
Thus, the asset quality of banks requires careful watching, especially during an
era of high credit growth.
(The authors work in the Division of Banking Studies, Dept. of Statistical Analysis
& Computer Services, Reserve Bank of India, Mumbai, and may be contacted by
e-mail at [email protected]. The views expressed are purely personal.)