Banks need structural, internal upgrades to reduce NPLs: Pros

Public sector banks in the country are likely to have been granted some relief in recognition of non-performing loans (NPLs), as the Reserve Bank of India (RBI) may have exempted them from providing for bad loans in case of certain stressed companies, sources say.Some corporates, likely to have been identified by banks as the ones to have made earnest effort to repay their debt, are expected to be part of this exemption list. Despite the likelihood of such an exemption and diligent efforts by banks to reduce NPLs, experts continue to maintain either negative or stable outlook on the sector, especially PSUs. “It (NPLs) is a legacy issue,” says Srikanth Vadlamani of Moody's Investors Service. While the stressed assets situation is looking up, improvement has been gradual, he says, adding, things are still far from perfect for banks. Market expert Dipan Mehta feels it is better for long term investors to stay away from public banks . “They cannot be part of core holding,” he says. A crucial reason for this is no visible change in internal management and services, he adds. Echoing the same sentiment, KC Chakraborty, former RBI deputy governor says while banks credit growth is between 9-10 percent, their expenses are increasing at nearly 11 percent. Due to this, incremental business goes into loss. Accountability of management and board needs to be made transparent for balance sheets to improve, he adds. Mehta expects that it will take another three to four quarter before the worst is over for banks in terms of stressed assets. However, he is positive on private banks like ICICI Bank and Axis Bank, which have shown considerable improvement in NPLs. Moody’s doesn’t see the ratings of banks improving in near-term, says Vadlamani.Below is the verbatim transcript of Srikanth Vadlamani, Dipan Mehta and Dr. KC Chakraborty’s interview with CNBC-TV18's Latha Venkatesh.Q: What is your sense? From your perch do you think that we are at least past the worst now, that the RBI forcing banks to recognise some of the loans has led to at least banks not giving more loans to stressed companies? Is the situation a little better now than it was six months back?Chakraborty: Very difficult to say at this stage because the non-performing asset (NPA) problem of the banks is not only due to environment. Also because of their internal appraisal system, governance standards etc. So, I don't see there is much improvement in the internal things, specially resolving the NPA accounts. Yes, if the environment gets better the pace of acquisition of NPA slows down. But I don't think they are out of the pain. They have to improve their appraisal methods, how to resolve the existing stressed assets and that will take more time and more structural reforms within the banks as also outside the bank.Q: Would you say that the fact that banks have been given a little more capital, some of their real estate revaluation assets have been given as capital as well there has been a little bit of action on the part of corporates also to sell off their non-core assets. We have seen significant action by the JP Group and other groups as well, smaller groups. The SDR rule probably will - in future also - lead to more stressed companies finding new partners, finding new investors. In that sense do you think the rules have started to work and maybe the mess in FY17 will be less than FY16?Chakraborty: We can hope for that. But one thing we must be very clear that credit growth of the banks is only 9-10 percent, deposits growth is 10 percent. Now their expenses are growing at 11-12 percent. Their incremental business is becoming loss making. Now unless they grow faster than the nominal growth rate of the system at least their expenses, the rate at which they are growing they have no future of the incremental business, all these things improving. Now you say steel sector has improved, but if you have a steel project which have not been implemented steel price improving is not going to help them.Now, yes, hoping is one thing. I don't have that detail thing, but what I say the total quantum of the stressed assets is so big legacy issues are so grave and the need for reform, better governance is so acute that unless we address these issues I don't think that banks will be able to get out of these problems so easily. Now, if you are saying that the environment is improving banks must redouble their effort to internally improve the administration and other issues then definitely they will come out, but I don't think it is going to happen so quickly.Q: Do you think we are at least starting some kind of structural change in the running of public sector banks, on this one aspect?Chakraborty: If they do it, I have no problem. But let me say that the public sector bank problem is not because of compensation issue. I don't agree that public sector chief executives or top management are less paid in the Indian context. In fact if you see globally compensation in the financial sector is a problem because people are saying they are paying too much to the financial sector people.What need to be done is that the compensation package need to be made transparent and it should be made more logical, this much only I can say. Then that also there has to be a reform because I agree at higher level maybe people are getting less, but we must also agree at lower level public sector banks are getting 3-4 times the market related salary and unless you change that structure and you right size the organisation you will be not able to increase the salary at the top. Now this requests different type of reform. But again let me say that compensation package was not the issue for the problem of the public sector banks.Q: The recent rise in commodity prices do you think now the pain on in the Indian banking system is significantly likely to reduce in terms of default loans.Vadlamani: Our view remains the same. There is clearly the fact that steel prices have improved and also the fact that there is a positive ignition that has come in as far as classifying some steel imports as being classified as dumping, so that has definitely helped the steel sector so that is definitely positive, but we don’t want to read too much into this. We are not yet sure whether this is a sign of real bottoming of commodity prices and whether there is going to be any meaningful uptick in commodity prices. If that happens clearly it’s a very big positive, but at this stage we don’t want to extrapolate the price movements over the last two months and say that commodities are finally showing up well on a permanent basis.Q: Is the Moody’s view of commodities that things won’t that get bad as they got in end 2015. Steel price fell to USD 250 even USD 240 per tonne, now they have risen to USD 400 per tonne, so is the Moody’s view that at least the worst of stress in commodities companies behind us that will mean the stress on banks is less.Vadlamani: Our medium term view on commodities is that we think it is going to be lower for longer, so it’s very hard to predict near term price movements and obviously there is a significant amount of volatility in these markets, but over the medium term we think some of the issues are structural, there is real overcapacity problem especially steel, so for the broader commodity complex our view remains that it is going to be lower for longer.Q: The more important point is that a lot of sectors have started showing growth. We were rattling out cement sales in the fourth quarter actually grew by 10 percent for all of 2015 they were growing by 2-4 percent. Likewise two-wheelers have shown an extremely healthy domestic growth even if exports are not helping them much in some cases like Bajaj Auto we saw even 30-40 percent growth in some months. The same could be said even of for commercial vehicles its now three years we have seen them steadily growing. So you do think the good book of the banks is slowly but steadily rising.Vadlamani: Sure from an economic environment perspective clearly things are looking up although they are looking up at very gradual pace, but the problems that the banks have is more of a legacy issue, in fact, I don’t think even in let say 12 months back or 18 months back, I don’t think the economy was deteriorating. The pace of implement may be in doubt but I don’t think it was seeing any deterioration. The problem is that the non-performing loans (NPL) issues that the banks are seeing now are a legacy of what they did over 2009-2012. It’s a question of recognition of them and it’s a question of providing for them which is a question of capital. So these are the issues and that’s why while economic growth will definitely help it’s a bit too much to expect that that will pull banks out of the NPL issues that they currently facing.Q: Would you start buying some of the stressed banks stocks now. Do you think that all the bad news is priced in?Mehta: I think some of the private sector banks which are under stress like ICICI and Axis Bank, we can see the end of the road over there and may be this move by the RBI will certainly improve the prospects over there at least the q4 numbers may be quite interesting and on the positive side because of the lower provisioning, but I am not that optimistic about the PSU banks and although there may be a trading opportunity in the PSU banks. These stocks cannot really be long-term investors they can’t be a part of the core holdings. On account of their past track records and basically nothing has changed in the management style or their systems which will prevent them from creating the same mess they are in just now.Q: Vinod Rai has just taken over and he has made some extremely right noises I would think on the public sector banking front. First of all reassuring bankers that if they took transparent decisions they will not be questioned, so even if they took a loan haircut which I think will be inevitable if they are going to sell-off some of their stressed assets, Rai and the Banks Board Bureau will look at the case from the merits of the decision. Do you think this is a good beginning he was very vocal about it, is that a good beginning that now banks will actively or proactively start looking at asset disposal?Mehta: I think it’s extremely positive and there is so much of pressure on the banks from some external forces and internal forces that this problem has to be solved somehow or the other it’s reached an level where it is now affecting the credit growth, it is affecting the economy and one of the reasons why the GDP growth is not improving. So, obviously the first that the problem has been recognised that has been taken. I think they will keep on finding solutions to try and resolve this matter and my sense is that may be give it 4-6 quarters or so and worst as far as provisioning is concerned would be over and done with. But in the long term we all know that unless there is a drastic change, a structural change in the PSU the way they operate you could have a problem like this 2-3 years down the line again. But yes I do believe now that may be 4-6 quarters down the line the worse would be over and what happens is that you will see an explosion of the profit after post tax level because actual provisioning amounts will come down and year-on-year they will come down significantly. They could be a fraction of what the provisioning have been made by the banking system as a whole and that in itself is a very positive for banks as a whole and for the Sensex and Nifty because they have the largest weightage in the banks and then you keep in mind that your interest rates also coming down at the same time credit growth also may pick up and if you look at the whole fundamentals, the industry fundamentals certainly going to look up, look far better 6-12 months down the line then they are just now.Q: You said that now see enough good news to turn positive on the corporate lenders in the private sector. By when do you think you will turn positive on the public sector?Mehta: We generally have been avoiding PSU all across all industries whether its banks or engineering or commodities or whatever and I don’t see that particular stance of us changing, so as I said that may be PSU banks are a good trading opportunity but for the long-term we need to be with the private sector banks.