The Hindu Business Line : 2004: A mixed bag for banks

THE fizz might have sputtered out of the champagne in the banking sector's low interest rate party, but customers may certainly have reason to break out the bubbly if they earn a little more on their deposits, in 2005.

Looking back, 2004 was the best of times and the worst of times for banks. It was a time for a significant spurt in credit demand; it was a time for hardening in interest rates. It was a time for consolidations in the banking sector; it was a time for scams and exposes.

Going forward, a lot of events that unfold in 2005, will find their roots in the seeds sown this year.

In the quest to build banks that are `world-class' in stature, the Union Government explicitly stated at several forums that it was in favour of consolidation in the Indian banking industry.

Mirroring the Centre's views, the markets have been agog with talks of consolidations among banks. If some media reports are to be believed, almost every bank in the country was looking to merge with every other bank. However, in the final analysis, there have been only three strong examples of mega-mergers among banks this year.

The first was with the public sector Oriental Bank of Commerce taking over the beleaguered private sector Global Trust Bank. The second was the merger of IDBI Bank into IDBI, which has been approved in principle and is expected to be completed by the end of the current fiscal.

The third, which is strongly rumoured to fructify anytime soon, is a merger between Bank of India, the third largest state-owned lender, with the public sector, Union Bank of India.

Consolidations aside, it has been business as usual for banks this year. However, most of them have taken a severe beating on their profits due to rising yields and falling prices in the domestic debt market. For some banks, in fact, the worst may be yet to come. Many did not take advantage of the central bank's facility of moving a portion of their SLR securities to the `held to maturity' category and thereby hedge their risks against rising rates and yields.

The problem was, that while banks were hoping to transfer the securities at a `book-value' without accounting for depreciation, the RBI had made it clear that the shifting of securities had to be done at the market price.

A number of banks thought that the rise in bond yields was a temporary one, and that they would wait and watch if it would continue. It remains to be seen if their gamble would pay off in the coming months. If not, then they may have to show huge losses on their balance sheets.

Depositors, however, stood to gain from the upward pressure on interest rates as most banks raised interest rates on deposits by up to 75 basis points. Lending rates were, by and large, left untouched by most. Earlier this year, a hardening in global oil prices and surplus rupee liquidity in the system, led the wholesale price index based inflation rate to surge to a three-and-a-half-year high of 8.17 per cent for the week ended August 21.

The yield on the ten-year benchmark Government paper also soared to over 7.2 per cent levels, reflecting apprehensions of rising rates in the market.

However, the inflation rate has eased over the last few weeks, declining to 6.73 per cent for the week-ended December 11, from 7.02 per cent in the previous week, leading bankers to form a view that interest rates may remain stable in the short-medium term.

Analysts are if the view, that if the growth in credit demand is sustained over the next year, that might inflict some further pressure on interest rates. Most banks have talked of an increase in off-take of credit from across sectors.

SBI clocked an year-on-year credit growth of 25 per cent. Other banks too have been reporting an increased demand for credit, especially from the mid-corporates segment.

2004 has also been plagued with scams and scares in the banking sector.

Depositors have never been more nervous about the safety of their funds in banks, as a result of which the slightest rumour would set off a run on a bank's deposits.

Bankers and rating agencies have now put the onus on depositors to ensure the safety of their deposits.

Looking ahead at 2005, bankers may be wiser for the experiences, in terms of over-playing the debt market. Depositors may be wiser and resist the lure of merely attractive rates for parking their funds.

On a lighter note, a wise old man once said, "Bank failures are caused by depositors who don't deposit enough money to cover losses due to the bank's mismanagement.''