Moneycontrol Pro Panorama | A shiny banking system must respect risk

India’s financial system is getting the global recognition it deserves, but are its own investors putting faith in banks?

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The Indian financial system’s comparison with global peers has never been so flattering as the present. There is good reason for it, especially when banks in the US are unfortunately facing trouble, Europe is struggling with its own set of problems and China hasn’t done anything different to fortify confidence in its financial system.

Against this backdrop, an Indian private sector bank is set to become the fourth largest globally in terms of market capitalisation, breezing past Morgan Stanley and just behind  JPMorgan Chase & Co, Industrial and Commercial Bank of China and Bank of America Corp. HDFC Bank has swallowed its parent HDFC and the merger is effective July 1. Its market valuation is already $172 billion.

HDFC Bank may be the doozy, but the rest of India’s banking system is no pedestrian. The Reserve Bank of India’s latest financial stability report (FSR) states that “the health of the Indian banking system is robust, fortified by non-performing loans at a multi-year low and adequate level of capital and liquidity buffers”. Indeed, delinquencies are at multi-year lows, capital adequacy is at an all-time high for banks. Incipient signs of stress are also limited, though not all corners are worry-proof. Our Chart of the Day details how unsecured retail loans have surged, and early stress signs are visible. But there is nothing that banks cannot handle because of the fortified capital profile they have. Stress tests show that no bank is at the risk of dropping below the minimum capital threshold in times of extreme duress. The pockets of pain remain the usual suspects – small businesses and microfinance.

India’s financial system is getting the global recognition it deserves, but are its own investors putting faith in banks? Most analysts still hold a positive view on banks and the Bank Nifty is holding onto its storied gains -- 31 percent -- of the past one year. In fact, Kotak Institutional Equities believes that valuations of banks are still attractive. Beyond that though, the brokerage differs from the FSR’s view. Our piece here highlights what the FSR states on equity valuations.

But no regulator is done with a communique without highlighting some concerns. Between its optimism on Indian economy and financial system’s robustness, RBI Governor Shaktikanta Das said, “It has to be remembered that seeds of vulnerability often get sown during good times when risks tend to get overlooked.”

In short, banks must be on guard when they underwrite risk, especially in good times. The art of lending is getting the monies back and India’s banks have had a shoddy track record. As this column examines, much of the cleaned-up books are a result of loans being written off and earnings foregone. The current fortified balance sheet is not entirely due to sound risk management, in fact far from it. The FSR shows that public sector banks yet again lead in the stress department with early stress signs highest on their books. One way to ensure prudence and accountability in PSU banks is to relook at the pay structure, as our columnist today argues.
Banks need to respect risk and so do markets. After all, as Howard Marks said, “Probable things fail to happen—and improbable things happen—all the time.”

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Aparna IyerMoneycontrol Pro