The Hindu Business Line : Old private sector banks

THE acquisition of a strategic stake in Vysya Bank by ING and the failure of Nedungadi Bank (the RBI has imposed curbs on withdrawal of deposits by customers) have firmly turned the spotlight on old generation private sector banks in the country. Even the RBI is keeping a close watch on them r. Overall, the impression is that while some of the banks in this sector are waiting to be taken over, the others are waiting to be bailed out.

The truth, however, is very different. A number of banks in this sector, consisting of scheduled banks that were not nationalised in 1969, are striving to maintain their identities nurtured over several decades. There is now more hope than before in their quest, thanks to a fall in interest rates that has helped boost profitability in the last several quarters. This has given these banks some time to clean up their balance-sheets which are riddled with non-performing assets (NPAs).

Challenges however remain. Most would need to rein in NPAs, manage the decline in spreads and also counter competition. Inevitably, the culling of the weak banks and acquisition of the best in the industry will happen , just as in every other industry. However, a few might still be around a decade from now.

Community banks

Old generation private banks started out and continue to function as community banks. They were nurtured and developed by particular communities. The source of their business was also largely from their linkages to such communities. The exception here is Jammu and Kashmir Bank, which has grown largely because the State Government's business has been conducted almost entirely through the bank.

Relationship finance was their mantra in an era when such terms were perhaps not even coined. Regional concentration is even now their feature, though growth may now be largely outside their spheres of dominance. Most banks have some 75 per cent of their branches in the State they were founded in. A large number of them were founded in Tamil Nadu and Kerala; 10 such banks operate in both these States.

Relationship banking allowed them to charge a higher rate on their advances. Customers did not complain because they had grown with the bank and were loyal to it. The result: Sizeable spreads but sedate growth. However, the NPAs that started to accumulate in the late 1990s spelt disaster for their financial health.

The NPA menace

In terms of economic logic, a higher return on advances can only mean a relatively higher level of NPA. So, if these banks are charging higher rates to their traditional business segment, higher NPA from those segments may not be altogether unexpected. Interestingly, however, for a predominant portion of the NPAs their traditional customers were not the cause.

For almost all old private banks, the main source of NPAs was industrial advances with a significant proportion being lent as part of a consortium. In particular, advances to steel, NBFCs and textiles turned bad. These NPAs were mainly the cause of the old private banks chasing higher return assets to deploy their fast rising deposit base.

The traditional customers were not those who brought the house down. The capacity of the traditional customer segment to absorb the available liquidity, boosted by rising deposit inflows, was low. The only choice was to lend it to outsiders. But the strategy of lending to higher-risk industrial segment backfired miserably. While it affected almost all old private banks, those with strong promoter holdings such as Benares State Bank and Nedungadi Bank have virtually gone under. Benares State Bank was merged with Bank of Baroda while the process for merger of Nedungadi Bank with Punjab National Bank is on.

Poor cousins

The emergence of NPAs left these banks busy fire-fighting through the late 1990s. That was when the best banks from both the public sector and the newly licensed segment crafted strategies to grow rapidly. These banks invested in technology, stealing a march over others, including the old private banks.

The old private banks now look like poor cousins of the successful new private sector banks such as HDFC Bank and UTI Bank. The woes of these banks stem from:

Cost of funds: This is higher than that of public sector banks by 75-100 basis points. The cost for such new entities as HDFC Bank is even lower. Importantly, their cost of funds has also not been as flexible to the falling interest rate regime as the cost of funds for public sector banks. Low-cost deposits accounted for nearly 23 per cent of the total deposits for old private banks. The ratios, for instance, were higher at 36 per cent for SBI and 41 per cent even for a new bank such as HDFC Bank.

Wage costs: These are only marginally lower than that of public sector banks while being substantially higher than that of the new generation banks.

NPAs: The level of net NPAs is similar to what is seen in many afflicted public sector banks. At the end of March 2002, only J&K Bank and Vysya Bank had a net-NPA-to-net-advances level of less than 5 per cent. For City Union Bank, Dhanalakshmi Bank, Federal Bank, United Western Bank, Lakshmi Vilas Bank and Nedungadi Bank, the NPA level was more than 8 per cent.

Lower technology penetration: The result is that the ratio of fee-based income to operating income is low. Banks are dependent on fund-based activities. In addition, ATMs are helping new banks add saving bank customers and reduce the cost of funds.

Lower business per branch: Business per branch is around 30 per cent lower than that of public sector banks. The historical factor of larger proportion of branches in the semi-urban and rural areas is beginning to haunt the old private banks. In fact, growth in operating income was on an average lower than even SBI's in the year ended March 2002. This can only be attributed to the spread of branch network in the semi-urban and rural areas that are practically recording no growth because of the poor industrial climate.

Breather in low interest rates

The only advantage that these banks have traditionally enjoyed is the higher return on their advances.

However, higher NPAs, higher wage costs, and lower business per branch ensured the negation of this advantage to a large extent. And the result was compression of profitability.

Now, however, the falling interest regime has proved helpful. The appreciation in the value of government securities has helped offset the impact of higher provisions. In fact, a number of banks has reported a rise in profits despite an increase in the proportion of net NPAs. They are sitting on sizeable levels of unrealised profits too.

Since the regime of low interest rates has come to stay and the rate of deposits growth continues to be strong, these banks now appear to have second chance.

If fresh generation of NPAs can be stemmed along with operational costs, then, even if spreads thin down, their financial health can improve. While their profit growth rate may yet be a big question mark, the opportunity to recover lost ground exists.

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