Banks to benefit from FM's proposals

The much-needed reforms in the banking sector have transformed the sector drastically in the last few years. Falling interest rates as well as strengthening of the hands of banks (Securitisation Act) have changed the dynamics of the Indian banking sector itself. The new Securitisation Act has given more power to the banking sector against defaulting borrowers. Further, changes to be implemented on the issue of voting rights among private sector banks is likely to speed up the consolidation process.

Budget Measures

	The government has proposed to double credit to the agriculture sector in the next three years.
	There has been a significant emphasis on making credit available towards infrastructure development.
	Inter-institutional group comprising select banks and financial institutions incorporated to ensure speedy conclusion of loan agreements for infrastructure projects. Nearly Rs 400 bn will be kept aside by this consortium for infrastructure support.
	Task force to be set up to explore reforms in the cooperative banking sector.
	Securitisation Act to be amended.
	FDI in the insurance sector to be hiked from 26% to 49%.

Budget Impact

	As per the common minimum program (CMP), the budget has focused a lot on the need to improve credit to the agriculture sector and banks will be at the forefront of disbursing credit. Vagaries of monsoons impact the agriculture sector heavily and banks are vulnerable if monsoon fails. Also, the RBI has released new guidelines for banks with regards to agricultural lending. However, it is too early to ascertain the impact. The impact of these initiatives by the government will only be apparent over the long-term.
	Banks are likely to benefit from increased lending to the infrastructure sector. This will come about in two ways i.e. direct equity participation and indirectly (corporates borrowing for expanding capacity). While this would provide an impetus to core advances of banks, the quality of such advances is likely to be better. In this light, there is relatively less NPA risk.
	Reforms in the banking sector in the form of amendments to the Securitisation Act may strengthen the backbone of the financial sector.
	A hike in the FDI in the insurance sector is likely to significantly raise investments in the nascent insurance sector. Domestic banks like ICICI Bank, ING Vysya, Kotak Bank and SBI who have joint ventures with international insurance majors will be able to infuse more capital into their insurance business. In the future, there may be an opportunity for these domestic banks to unlock value from such investments as well.

Sector Outlook

The banking and finance sector is witnessing a revival in credit offtake from the non-food segment. Also, with the government emphasizing on the need to boost credit to the agriculture sector, the issue of NPAs could resurface. While we believe that overall credit growth is likely to move into a higher growth trajectory as compared to the past, not all banks will be able to reap the benefit from such sector trends. In the past, falling interest rates have helped most public sector banks to significantly improve their profitability owing to large profits from trading activities. With interest rates expected to harden, these profits may dry out, thus affecting profitability. Investors need to tread cautiously at this stage, as only a few banks will be able to balance the growth prospects together with the emerging concerns in the sector.

Industry Wish List

	Abolition of tax deducted at source on bank fixed deposits.
	Increase in the foreign investment limit in Private sector banks to 74% and state run banks to 49%.
	The Indian Banking Association (IBA) has suggested the relaxation for listed banks and financial institutions from adhering to accounting standards not synchronous with banking operations. (Globally there is separate set of accounting standards for banks under IAS - 42).
	Tax benefits allowed to individuals in respect of housing loans may be continued.

Budget over the years

Budget 2001-02	Budget 2002-03	Budget 2003-04

Reduction in dividend tax to 10% from 20%. Cut in small savings rates 1-1.5% Limit for TDS on deposits reduced to Rs 2,500 from the current Rs 10,000. Abolishment of banking service recruitment board	Cut in most administered interest rates by 0.5% (by 50 basis points) from March 1, 2002. Setting up of Asset Reconstruction Company by June 2002. Banks are now allowed to deduct 7.5% of their total income against provisions made by them for bad and doubtful debts. Banks are given option to deduct up to 10% of their non-performing assets (NPAs) falling in the category of loss or doubtful assets from total income. Bill on the banking sector reforms is to be introduced in Parliament. Foreign banks permitted to operate in India with fully owned branches after the specific permission of RBI.	The FDI limit in private sector banks has been raised to 74% from the existing 49%. The SBI will have to lend at lower rates to the agricultural sector as well as SSIs. SBI will now offer loans in the range 2% above its Prime Lending Rate (PLR) or 2% below its PLR. Tax exemption on interest on housing loans maintained at Rs 150,000 per year. The government has agreed to buy back older government borrowing with high interest rates from banks. Reduction in the interest rates on all small savings schemes by 1%.

Key Positives

	Securitisation Act fillip - Improved asset quality
	VRS push - PSU banks like SBI, BOB and BOI after having successfully implementing VRS schemes, have become much more streamlined and efficient. This is likely to result not only in higher cash flow in the future, but also long term benefits like improvement in efficiency levels.
	Retail segment driver - Low interest rates have led to a dramatic growth in credit off take from the retail segment. And this has helped banks to weather a weak industrial credit offtake scenario. Going forward, with the revival in the industrial sector ands robust volumes in the retail segment, banks are in a good position to tap this expected demand.
	Government proactiveness - The government may take a second look at the issue of FDI limits and voting right limits in the private sector banks. If the policy is further amended in the form of higher FSDI limits and a removal of voting right ceiling of 10%, then we may see further consolidation among private sector banks.
	Improved asset quality - Most of the public sector banks that have been ridden by huge NPAs in the past have been able to restructure and provides aggressively for their NPAs in the last 2-3 years. This has helped these banks to significantly improve their asset quality and they are now in a much better position to tap the emerging opportunities in the domestic market.

Key Negatives

	Agri lending concerns - The government has announced measures to boost lending to the agricultural sector and banks will have to be at the forefront of this scheme and this means that they will have to significantly increase their exposure to this segment. With the unpredictability of the monsoons a reality in the country and lack of proper irrigation facilities, lending to the agri sector is fraught with risks and going forwards banks may witness a higher rate of defaults in this sector.
	Lack of policy clarity - Although the government has increased the FDI limit to 49%, it is not yet clear that whether FDI limit includes FII limit also. Also the limit for state run banks still stands at 20%. This will limit the scope of consolidation in this sector and consequently the benefits of scale to the various participants. Also the new government has indicated that there will be no sell off of stake in public sector banks in the country. Thus further limiting the scope of consolidation in the sector.
	Interest rate dampener - The Indian economy is witnessing rising inflationary pressure and this has the potential to curtail the credit growth in the economy. As inflation inches close to the 6% mark, the Reserve Bank of India (RBI) may be forced to hike interest rates and this may prohibit potential borrowers from borrowing. A hike in interest rates may have a bigger impact on the high growth retail segment, which has a higher sensitivity to rising interest rates. Thus to that extent banks may witness a slowdown in credit offtake.

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