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As we enter 2004, I can say with satisfaction that the Indian banking sector is in the process of transforming itself into a strong globally competitive entity, setting aside all the apprehensions regarding huge non-performing assets. The banking system has been able to reduce the level of net non-performing assets substantially and has become tech savvy.
The lower credit off-take and decline in interest rates was a blessing in disguise. Given these facts, 2003 was the most challenging year as interest incomes declined substantially, while the cost of funds did not reduce proportionately. Due to lower credit offtake during the past few years, banks were forced to remain heavily invested in government securities. This in turn helped the banks by way of huge appreciation in the secondary market. An efficient management of the treasury operation has given a huge bonanza to all the banks — big or small.
In the first half of current fiscal, public sector banks’ performance was impressive. While the overall business conditions did not improve much, banks continued with their policy of focusing on margin improvement and using bond gains to clean up their books.
However, all the three major concerns relating to public sector banks a couple of years ago — bad loans, operational inefficiency and poor technology platforms —are being addressed now. I believe that net nonperforming assets are now not detrimental in today’ s balance sheets in most of the public sector banks. On the operational front, the cost to income ratio has fallen from a high of 60 per cent to a low of 40 per cent.
With the changing business dynamics, 2004 is going to be more challenging. I believe that the interest rates in India have more or less bottomed out. We have witnessed a fall of over 600 basis points in 10-year paper over the last three years. Longer-term interest rates should stabilise in the 5 to 5.5% range for the next couple of quarters.
While the banks have significant cushions available in their portfolio to withstand shocks from rate reversals, there could be a fall in bond gains in financial year 2005.
The turnaround of the Indian economy is expected to help the banking sector. All the three segments — agriculture, industry and services — are expected to do well in the current year.
Banks have exposure to all the three segments and public sector banks still control around 80% of the total exposure. While retail has been the only growth driver for the last couple of years, we expect demand to pick up from other constituents also.
Moreover, banks should also recover dues from the core sectors, which would add to their bottomlines, as good portions of these dues have been provided for or written off.
Here onwards, I believe the core drivers of profitability of public sector banks would be loan growth and further reduction in operating costs by use of technology and also reducing their gross NPAs.
I also believe that there will be a consolidation in the banking system. This will help them in becoming more competitive globally and have capacity to withstand any pressure that might eventually come.
<i>The author is CMD, Punjab National Bank</i>