PSU Bank Mergers May Weigh On Credit Growth, Says India Ratings

With public sector banks facing ageing provisions and an increase in stressed corporate accounts, the proposed bank mergers court hurt credit growth due to asset-quality pressures, according to India Ratings and Research Pvt. Ltd.

The rating agency, which placed most public sector banks under “rating watch evolving” on Sept. 4, said the credit growth could take a back seat as the merged entities would need to “harmonise” their stressed accounts as well as manage any asset-liability mismatch.

“Rating watch evolving” means the current credit rating can be upgraded, downgraded or affirmed depending on future outcomes.

The merged banks will have to focus on several challenges, including human resources and technological integration, among others. Thus, credit growth and asset recovery may not receive adequate attention, it said in a report titled ‘Bank Credit Outlook For FY20’.

On the other hand, the five state-run lenders that were excluded from the bank merger process could see their balance sheets shrink, India Ratings said, adding it may lead to the requirement of additional capital infusion in FY20-21. The ratings agency has a ‘negative’ outlook for these five lenders.

Rise In Credit Costs

Banks’ credit cost is expected to rise in the ongoing financial year as the pace of resolution of stressed assets slowed in the past six months, India Ratings said.

The credit cost for the banking sector could increase to 4.6 percent in the second half of 2019-20 from an earlier estimate of 4.4 percent, it said. Public sector lenders alone could witness a 30-basis-point rise in credit costs to 5.2 percent during the period.

Credit cost may rise mainly because of an increase in bad loans in agriculture sector and small businesses over financial years ending March 2020 and March 2021, India Ratings said.

“With the Reserve Bank of India giving forbearance to the MSME (micro, small and medium enterprises) sector until end-FY20, some of the incremental stress in this segment could show up in FY21, unless the economy picks up,” the ratings agency said. “Muted rural income growth, along with announcements or expectations of farm loan waivers continue to weigh on asset quality of the agriculture sector.”

Several defaults by non-bank lenders over the last year, too, raised the credit costs for public sector banks. Non-banking financial companies added Rs 55,000 crore, or 0.5 percent, to the total stressed corporate assets of banks in 2018-19, India Ratings said.

Total stressed corporate and NBFC accounts of banks stood at 3.9 percent as of March 2019, it said.

Asset Liability Mismatch

Asset-liability profile of anchor banks such as Canara Bank, Union Bank of India and Punjab National Bank may deteriorate after the proposed bank mergers, according to India Ratings. That’s because of wide asset-liability gaps in smaller peers to be merged.

Jindal Haria, director (financial Institutions), and Ruhi Pabari, analyst, at the ratings agency, cited the instance of merger of Bank of Baroda, Dena Bank and Vijaya Bank.

Before amalgamation, Bank of Baroda had a small asset-liability gap, while Dena Bank and Vijaya Bank had large gaps. When these entities were merged, the asset-liability mismatch of the consolidated entity stood at 10 percent, they said. While a 10 percent gap is not alarming, what it means is that the merged entity will need time and resources to mend the gap, they said in a conference call with reporters.

“Banks that are in a weaker position will be able to refinance at a somewhat higher rate, which will impact their margins. So, they will need to fund the gap by raising short-term deposits or offer higher deposit rates or borrow at longer terms,” they said. If liabilities are at a higher cost for one bank compared to others, it will remain at an elevated level going forward, they said.