Money & Banking

Net interest margin rises, asset quality falls

Biswa Swarup Misra | Updated on November 14, 2017


Improvement in net interest margin and ‘other income' counters deterioration in asset quality

The Indian economy, at the present juncture, finds itself in a tight spot. Both domestic and global factors have contributed to the slowdown of the economy. How have banks performed in this macro environment?

Recently, the banks announced their business and financial performance in the second quarter of 2011-12. Among other things, an elevated interest rate environment and the move towards system-based recognition of NPAs (non-performing assets) are the two major factors which have a direct bearing on the performance of the banks.

In this backdrop, how the macro and bank-specific factors have played out in influencing the performance of banks in the second quarter would be of interest. We consider the nationalised banks (NBs) which account for almost half of the assets of the banking system.

Business mix

We find that the business mix of the NBs has improved significantly in the second quarter on a sequential basis — in the September quarter over the June quarter (3.2 per cent) as compared to in the June quarter over the quarter ending March 2011 (0.5 per cent).

We also observe that asset quality represented through both the gross and net NPAs in absolute as well as in percentage terms have deteriorated for NBs in the September quarter on a sequential basis.

While the gross NPA percentage increased by 17 basis points (100 basis points equal one percentage point) in the June quarter, it increased by 26 bps in the September quarter. However, the RoA (return on assets) and cost-to-income ratio for NBs have improved in the September quarter.

An improvement in RoA, the summary account of the performance of the NBs, however, may not portray the correct picture as it could mask the stark difference in the performance across different NBs. To have a comparative sense of the performance across NBs, we consider two categories of them based on their business mix.

The average business mix of the 19 NBs, excluding IDBI Bank, was 2.7-lakh crore as on March 2011. Six banks had a business size more than the average, which constitute the group of large banks, and the rest 13 constitute the group of small banks that had a business size lower than the average.

One way of gauging performance of a going concern in a particular time period is to compare it with the corresponding period of the previous year. However, year-on-year comparisons would make better sense for annual data than quarterly data. For quarterly data, it is easier to relate to what had happened in the previous quarter than three quarters back.

Using y-o-y figures for quarterly data is akin to setting the reference period for comparison to a four-year back period for annual data. As such, we consider how the two categories of banks have performed in the second quarter on a sequential basis.

Credit, deposit growth

Both the large and small banks witnessed better growth in resource mobilisation as well as utilisation in the September quarter on a sequential basis. In terms of deposits, the growth for large banks was 3.2 per cent and 4.1 per cent for the small banks on a sequential basis. Advances growth was only 2 per cent for the large banks and 3.1 per cent for the small banks.

This can be compared with a growth of 1.4 per cent and -0.03 per cent in deposits and -0.6 per cent and 1.1 per cent in advances for the large and small banks, respectively, in the June quarter. As we can see, the growth in deposits was much higher than that in advances. Thus, the fall in C-D ratio for both the small and the large banks has been of a lower magnitude in the September quarter over the June quarter.

Interest income, expenses

The growth in interest income as well as interest expenses slowed for both categories of banks in the September quarter. However, the deceleration was more on the expenses front. As such, NII grew significantly for both categories of banks. The robust growth in NII had a positive impact on the NIM. Unlike in the June quarter, when NIM of both small and large banks declined compared to the quarter ended March 2011, NIM of both categories of banks improved in the Sep quarter. The degree of improvement for the large and small banks was also of the same order of around 15 bps.

Looking at the individual bank numbers, except two banks in the smaller category, all other banks reported an increase in NIM in the second quarter on a sequential basis. As we know, NIMs are influenced by a host of factors, including the extent and periodicity of increase in rates, maturity profile of deposits and the relative growth of advance vis-à-vis deposits.

The improvement in NIMs was possible because banks have not been too aggressive in increasing their deposit rates notwithstanding the increase in policy rates as deposit growth has been relatively higher than credit growth in the September quarter.

The large banks reported significant growth in the non-interest income in the September quarter on a sequential basis. While all the six banks in this category reported a drop in non-interest income in the June quarter over the March quarter.

Non-interest income

In the September quarter only one bank reported a drop in non-interest income over the June quarter. Compared to a drop of 25 per cent in the June quarter, there was a growth of 12 per cent in the non interest income for the large banks as a group. In contrast, the growth in non-interest income for the small banks was only 0.3 per cent in the September quarter.

Nine banks reported a drop in non-interest income both in the June and September quarters in the small bank category. Though non-interest income is a composite category, its core component has a correspondence with the credit business. As such, the relatively higher credit growth of big banks in the second quarter from negative growth in the first quarter would have contributed to their core fee income.

The recovery from written-off accounts has also increased significantly for a number of large banks, contributing to their non-interest income.

The cost-to-income ratio has improved sequentially both in the June and the September quarters compared to the March quarter for both categories of banks and now this ratio is almost similar for both categories of the banks at around 43.5 per cent.

However, if we see the improvement in operating efficiency over the last two quarters, it has been quite significant for the large banks.

The improvement is attributable partly to the robust growth in non-interest income and to the high base effect. However, looking at individual bank numbers, as many as three banks in the large bank category and four banks in the smaller category have reported deterioration in this ratio in the September quarter over the June quarter.

NPA trend

The large banks started with a lower percentage of gross NPA (1.84) than the smaller banks (1.97) in the quarter ended March 2011. In the subsequent two quarters, the gross NPA percentages have increased for both categories of banks but the rise has been more pronounced for the large banks.

For the September quarter, the gross NPA percentage for the large and the small banks was observed at 2.44 per cent and 2.32 per cent respectively. Seen in absolute terms, the gross NPA has increased by 7.6 per cent and 2.8 per cent in the Sept quarter over the June quarter for the large and the small banks respectively. This is on top of a growth in absolute NPA of 4.1 per cent and 8.6 per cent in the June quarter over the March quarter for the large and the small banks respectively.

Return on assets

If we consider the RoA figures for the quarter ended March 2011, we find that the large banks reported significantly higher numbers (1.01) than the small banks (0.82). Moving forward, RoA fell markedly for the large banks to 0.86, whereas for the small banks as a group it improved a tad to 0.83 in the June quarter. In the September quarter, RoA of the large banks as a group declined marginally (0.85) whereas small banks as a group (0.86) reported marginal improvement.

The big banks suffered a major deterioration in their NPAs in the September quarter. It is the improved NIMs, better growth in business and improved performance on the non-interest income front which has protected their RoA levels. The small banks were also affected by the NPA problem but to a lesser degree.

It is the restrained growth in operating expenses and robust growth in business which helped them to marginally improve their RoAs.

While the Finance Ministry, as the owner, had asked the NBs to migrate to system recognition of NPAs by September 31, 2011, the RBI, as the regulator, has given time till October 31, 2011. Some banks have reported compliance to the direction of the Finance Ministry and quite a number of banks are yet to fully migrate to the new system.

Though a number of banks have reported higher NPA numbers post-migration, it has created the necessary sensitisation about recovery and one would expect better performance on the NPA front for these banks in the subsequent quarters of 2011-12. For those banks which are yet to migrate, time to swallow for the bitter pill has come.

(The author is Associate Professor, Xavier Institute of Management, Bhubaneswar. The views are personal.)

Published on December 04, 2011

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