High exposure to sectors such as power and small and medium enterprises, or SMEs, threatens to weigh down state-run lenders as slowing economic growth and a policy impasse hurt companies in these sectors.
Some of India's top state-run lenders have reported a rise in their outstanding restructured loans. Punjab National Bank, Canara Bank, Bank of Baroda and Bank of India have high-risk loan portfolios. Over the past few quarters, most public sector banks reported a rise in bad loans while their counterparts among private banks showed that their asset quality was relatively stable.
In the April-June 2011 quarter, provisions or funds set aside for bad loans by banks rose almost 100% for state-run banks at a time when private banks posted a decline of close to 30%.
The gross ratio of non-performing loans (NPLs), of all banks rose marginally to 2.52% at the end of June '11 compared with 2.35 % in March '11.
Power, textiles, real estate and SMEs are some of the sectors which are more vulnerable to a change in macroeconomic conditions.
A slowdown in the economy coupled with interest-rate tightening to cool inflation is already hurting companies in these segments. Of the total loans to the power sector, the share of public sector banks is 7.2%.
According to a report by UBS Investment Research, close to 40% of power exposure (which is 3.2% of the total loans) is expected to turn into NPLs, or restructured loans. Canara Bank, Corporation Bank and IOB have an exposure of more than 15% to this sector and could well take a big hit if the sector is impacted further.
SMEs comprise another sensitive sector which is expected to feel the heat with interest rates on the boil. Indian banks have an exposure of close to 17% to this segment.
Some of the banks such as State Bank of India are already under pressure due to bad loans given to the mid-corporate and small enterprises sectors over the past couple of quarters. The realty sector too has been hit but Indian banks appear to have been chastened after the experience of 2008.
Their exposure to the commercial real estate sector is a shade below 2%, thanks to a regulatory fiat, although ICICI, Axis, and Bank of Baroda appear to have raised their share of commercial real estate loans.
If some of the restructured loans turn to bad loans over the next year or so, lenders such as PNB and Bank of India could be impacted, considering that their restructured loan book is high. The slide in bank stocks reflects this risk of NPLs to some extent.
While valuations appear more reasonable now, given weakening macroeconomic conditions, investors may choose to be selective and buy stocks with the lowest asset quality risks. In this context, private banks may continue to trade at a premium due to relatively low-asset quality risk.
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