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India Strategy: Expecting PSB's to deliver too much too quickly

The Finance Minister (FM) announced another set of measures relating banking sector including a follow-up from last week’s announcement, which has been quick amid plummeting real GDP growth at 5% in Q1FY20, a 6 years low. The recent slew of announcements was centred on the mega plan of consolidation of public sector banks (PSBs). Following the mergers under four groups, the number of PSBs will be reduced to 12 from the initial count of 27. The consolidation is expected to drive efficiency, productivity, better capital allocation and credit growth. With this the FM expects PSBs to play a significant role in achieving the Government’s objective of USD 5tn economy by 2024. With these measures, we believe the government is telling us that while it is has taken expedient measures to get back the economy on track, it is reinforcing the sentiment that it is also taking structural reform measures.

Overall, the coordinated steps taken by the government-RBI and deployment of PSBs to infuse liquidity will help counter the current cyclical growth deceleration. We are enthused about the bank consolidation plan announced by the FM, however, we believe there the dividends are significantly back ended. Near term pressure on their profitability will sustain even as they demonstrate better growth. Hence, we maintain our Underweight view on PSBs.

Update on liquidity measures has been quick:  Given the sharp drop in growth and pervasive liquidity crunch, the update on the measures taken last week was more relevant. The FM informed that PSBs have adopted repo-linked lending rate for mortgage loans, relief to MSMEs through loan management system and loan settlements have been initiated. Four NBFCs have found liquidity solutions through PSBs and co-origination of MSME loans is being worked out. The FM enumerated 10 PSBs who will get recapitalisation of Rs 553bn out of the budgeted Rs 700bn in FY20.

PSB consolidation is desirable, but objectives are getting overloaded: While the PSB consolidation is desirable, we believe the PSBs may be subjected to heavy-lifting too soon. PSB banks that have just limped back from a prolonged stressed scenario and are now deployed to simultaneously work on executing last week’s announcement of liquidity & rate transmission and work towards consolidation. The consolidation of BoB-Vijaya bank-Dena bank has still to season enough. And SBI and associate banks consolidation has taken over two years to settle.

Good governance is great, but obfuscating near term priorities: The FM has emphasised on the measures taken to ensure stronger governance of the PSBs, however, the fact remains that the infusion of capital of Rs 700bn, frontloaded last week, comes with directives of quicker transmission of rate cuts, and sectoral focus on lending, including retail, MSME, NBFC, agriculture, housing etc, which will be impact their margins in the foreseeable future. These multiple objectives may obfuscate near term priorities for the PSBs.

Consolidation to drive productivity, but will need more capital: It is unrealistic to assume that PSBs are back on track for self-sustaining credit growth path. Consolidation process will lead to capital loss from increased provisioning and thus, require additional capital. It will take them at least couple of year to derive productivity and efficiency gains from the consolidation process as the business per employee will improve gradually as along with natural pace of attrition of employee. In addition, they will have to grapple with potential rise in NPAs amid the current cyclical slowdown.