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NPAs: PSU banks lead change

November 24, 2004 10:42 IST

Banking stocks are once again in the limelight on the bourses. While last time, the surge in banking stocks was on the back of improving scenario for the industry owing to falling interest rates, this time around, the optimism towards the sector could be attributed to the rise in interest rates.

Strong credit growth on the back of enhanced capital expenditure by India Inc augurs well for the banking industry's core business growth going forward.

However, in this article, we shall look at the extent to which the domestic banking industry has benefited from falling interest rates over the last few years.

Data culled out from the RBI Annual Report 2003-04 confirms the big advantage that the banking industry has had over the last few years, primarily owing to falling domestic interest rates.

It must be noted that between the periods FY97 to FY04, bank rate fell from 12% to 6%. While the industry has benefited from the increased lending triggered by low interest rates (mainly in the retail segment), the bigger effect of this has been reflected on the G-sec portfolio of banks.

Bond prices and interest rates have an inverse relationship. Thus, the significant fall in interest rates led to windfall gains for banks on their G-sec portfolios.

Net NPAs to Net Advances (Public Sector Banks - incld. SBI Group)

% of banks with NPAs less than/equal to
10% NPAs
NPAs greater than
10% NPAs
FY97 63% 37%
FY01 81% 19%
FY02 89% 11%
FY03 93% 7%
FY04 (P) 96% 4%
Source: RBI Annual Report 2003-04

Public sector banks were the major beneficiaries of this owing to their huge exposure to government paper. This money was used to clean up their balance sheets (as is evident from the table above), which was burdened by huge non-performing assets (NPAs).

Upgradation, restructuring, recovery of assets (in part due to Securitisation Act), as well as disbursal of loans with strong checks (like credit worthiness)

are some of the measures which has helped improve the NPA scenario. Private sector banks also took advantage of this situation.

However, the impact of this is not too evident (see table below) owing to the fact that these banks were already relatively efficient owing to the stricter norms followed by them while disbursing loans.

Net NPAs to Net Advances (Private Sector Banks)

% of banks with NPAs less than/equal to
10% NPAs
NPAs greater than
10% NPAs
FY97 91% 9%
FY01 77% 23%
FY02 81% 19%
FY03 90% 10%
FY04 (P) 90% 10%
Source: RBI Annual Report 2003-04

Going forward, it must be noted that the Indian economy is at the cusp of an investment cycle and banks will play a pivotal role in realising the objective of an 8% GDP growth.

Further, as the Indian banking sector is slowly discovering the growth potential of the retail segment, investors need to carefully evaluate the strategies of banks for the retail segment. This is because the experience of most Indian banks, especially the public sectors banks, is limited in the retail segment and investors need to keep a watch on any potential negative surprises on the NPA front in the long run.

While, overall, higher growth in the sector seems inevitable, investors need to be cautious and take selective exposure in the same. is one of India's premier finance portals. The web site offers a user-friendly portfolio tracker, a weekly buy/sell recommendation service and research reports on India's top companies.