Performing assets

As businesses go, banking is largely a commodity business banks borrow money from those who have excess of it and lend it to those who need it, and try to earn a spread.

As businesses go, banking is largely a commodity business banks borrow money from those who have excess of it and lend it to those who need it, and try to earn a spread. Brand recall matters, but more than that it is how favourable interest rates are, and how extensive and efficient a bank8217;s services are, that draw customers to it. With competition intensifying, spreads 8212; the difference between a bank8217;s cost of lending and cost of borrowing 8212; have shrunk from 4-5 per cent to around 3 per cent in just the last two years, and are expected to stay there. And banking stocks in general have trailed the broad market. Bleak times for the 38 listed bank stocks?

For weak banks, maybe. For decent and strong banks, not at all. Banking, along with a bunch of other sectors essential to India8217;s growth and progress, is tipped to be a winner. Growth patterns of banks tend to show a high degree of correlation with the economy. An economy growing at 8 per cent a year translates into 20-30 per cent annual growth in bank assets. A bank scaling up at such levels can easily offset the impact of diminishing margins, but not all banks will manage to do so. In a business where big is good and bigger is better, many will, in fact, struggle to stay competitive.

Everybody, from bank chiefs to the Reserve Bank of India to Dalal Street, thinks so, and are either baying or hoping for a clutch of consolidation moves in the sector. Last month, investors greeted the sealing of two alliances one loose Corporation Bank, Indian Bank and the Oriental Bank of Commerce and one tight merger of Lord Krishna Bank into Centurion Bank of Punjab with a 10 per cent rise in the BSE banking index, twice as much as the BSE Sensex. Says Hitesh Kuwelkar, associate director research, First Global, a brokerage: 8220;Consolidation is just what the sector needs now. Banking is a size game, as well as about technology and expertise. Those who understand this will be able to offer better products at lower costs.8221;

But as things stand today, translating that theory into practice isn8217;t straight-forward. There are synergies and areas of overlap between public sector banks, but mergers between them won8217;t be easy, as the Banking Regulation Act will have to be amended, which the Left is unlikely to allow. For now, the best these banks can do is forge Corporation-Indian-OBC kind of alliances.

An inability to do right to the business is one of the reasons why public sector banks, despite keeping pace on the growth front in the last five years, are the least valued among back stocks. Legacy issues is the other, though public sector banks have made huge advances, by relative standards. They have used treasury profits to reduce their bad debts to below 5 per cent of advances. They have computerised branches and are matching private players in rolling out ATMs. Yet, analysts say, public sector banks are still playing catch up. Says Kuwelkar: 8220;They have to improve their competitiveness. You have to offer the best products. With their global expertise, foreign banks could take away the best of clients.8221;

Till the government waves the green flag for public sector bank mergers, it8217;s unlikely they will get the premium the market hands out to new private banks, who are more efficient and more insulated from economic cycles. Over a five-year period, for example, listed public sector banks have done well, benefiting from the pick up in credit and the fall in interest rates. But over a three-year period, when banks have felt the heat from rising interest rates, it8217;s the new private banks, with their greater retail-orientation and higher fee-based income, who have done better See graphic.

Private banks are generally more adept at making growth moves, be it through M038;As or through internal expansion. Says K.V. Kamath, managing director and CEO, ICICI Bank: None of our businesses have really reached the maturity stage, we are still in the growth cycle.8221; Non-food credit extended by scheduled commercial banks recorded an average annual growth of 26.1 per cent between 2002-03 and 2005-06, compared to 14.5 per cent during the preceding four-year period.

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While the market does warm up to organic growth stories, what it really likes is M038;As that make business sense. In a growing and fragmented industry, there should be many stories like that. Says Punit Srivastava, analyst, Enam Financial: 8220;Banks in which foreign banks could acquire a stake are the stories the market is interested in. Some of the old private sector banks, with their regional but strong deposit base, could offer some leverage and synergies.8221; For example, Centurion8217;s expertise of retail lending and SME business was a good fit with Lord Krishna Bank8217;s deposit base. If and when the decks are cleared for public sector banks to go for M038;As, the action could just explode.