You might think that given high credit growth, banks should be doing rather well. But if you looked at the financial performance of banks in the last quarter of the year, you might want to think again. Because financial services — mainly banks — have not done too well in the fourth quarter (Q4) of 2010-11 (FY11). State Bank of India, the country’s largest, surprised everyone with net profits way below expectations. The reason: it took a big charge on its housing loan portfolio, having to provision for possible losses. True, it might have been an exceptional quarter, and came almost immediately on the heels of the retirement of chairman O.P. Bhatt, who was a fairly aggressive banker. The overall performance was a mixed bag: some such as HDFC Bank and Axis Bank continued to do well, as did some of the smaller private sector banks such as Dhanlaxmi Bank. Public sector banks took some larger than expected charges on income, mostly from pension provision for retired staff. “Financial services are the engine of growth, according to one analogy. And the oil that greases the economy, according to another,” says the head of a leading investment banking firm. “Either comparison works when you look at what is happening currently.” The lag between deposit growth and credit growth is straining the engine, causing some damage to engine parts, and needed repairs (making provisions, and restructuring loan portfolios, perhaps) to balance sheets. Hikes in policy rates by the Reserve Bank of India (RBI) are similar to high oil prices, which when they go too high, slow down economic activity, as businesses and industry pedal back on their plans. The financial services industry is also the engine that drives stockmarkets. They account for nearly a quarter of the weight in both the Bombay Stock Exchange (BSE) Sensex and the National Stock Exchange’s Nifty. Along with liquidity, financial services firms need capital, and in continuous supply. Many may have to review portfolio composition (infrastructure has been a big borrower recently) and address long-term asset quality issues. The economy may be slowing down, but credit demand does not appear to be slackening. That means reliance on the banking system is not going to come off. Perhaps, more than the year past, it is the next four quarters where financial services firms — mainly banks — are likely to feel the pinch. “For businesses, they (interest rates) are already high,” says Avinash Nahata, head of fundamental desk at Aditya Birla Money, a part of the Aditya Birla Financial Services. “Demand for capital expenditure and retail credit, coupled with asset quality concerns, could push them up even higher.” Continuous rate hikes by the central bank have impacted net interest margins (NIMs, or the difference between interest paid on deposits and interest earned on loans) of financial services firms. If that is not bad enough, more policy interest hikes are on the anvil, as the RBI continues its battle on inflation. In its annual monetary policy statement early last month, the RBI said national output, as measured by gross domestic product or GDP, was likely to be lower in FY12. That would keep the banking industry’s performance in particular under pressure.
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