Due to the second wave of the pandemic, Q1FY22 was a devastating quarter for banks as stress accumulated on the asset side, and collections and recoveries took a hit because of a complete stop in economic activity. With increasing provisions and gross NPAs, and decreasing profits, the banking sector barely dodged a catastrophe.

In Q2FY22, however, banks are celebrating. Profits are increasing, net interest incomes are going up, and operating incomes are improving. With the second wave fading and vaccinations increasing, other sectors are seeing businesses grow at pre-Covid levels. 

Loan disbursements and credit growth were anemic in Q1FY22 with credit growth at just 6% YoY. In Q2, credit growth rose sharply, and banks are seeing a rise in their net interest income and revenues. With banks being flush with liquidity, most of them are hoping to boost loan growth as the economy stabilizes. 

NPAs fall YoY for most public sector banks

State Bank of India, IDBI Bank, Indian Overseas Bank, and Canara Bank have reported a dip in net NPAs improving their asset quality in Q2FY22. Fall in NPAs led to increasing lending in agriculture, industry, tourism, and real estate sectors.

IDBI Bank had a different scenario building up. Their bulk deposits saw a steep decline by 53% YoY and 27% QoQ to Rs 14,651 crore in Q2FY22. This led to a decrease in the share of retail advances from 26.3% to 26%, and MSME advances fell from 21% to 19% in Q1FY22. 

Public sector banks have overall outperformed private sector banks in improving their asset quality. This could be because of the higher provisioning ratio of public sector banks. As per reports, PSU banks' NPA provisioning increased to 68%. 

Agri-sector lending performed well with an average growth of 20% YoY in Q1FY21. Credit growth was negative for most banks and despite slight growth in Q1FY22, it wasn’t enough for banks to come at par with pre-Covid level numbers. In Q2FY22, industry credit grew 2.5% YoY, led by growth in the MSME segment. Service credit grew 0.8% and real estate which took a major hit also rose by 1.4% YoY. 

NPAs worsen for several private banks

Most private banks saw their net NPAs rise in Q2FY22. Net NPAs for HDFC Bank and Kotak Mahindra Bank rose more than 20 bps YoY. The market movement has been slow in lockdown and most banks rely on agents on foot to manage the collections. With things opening up and collections improving, slippages are expected to reduce.

The NPAs reduction trend began at the start of FY22.  ICICI Bank, Axis Bank are a few banks that saw this trend in their numbers. 

Falling NPAs is a good sign as it indicates higher liquidity for banks. Higher NPAs mean the bank's profitability, net interest margins, dividend payout gets pulled down. Once a bank’s asset quality deteriorates, credit inflow also reduces. In this regard, for the banking industry to operate on a healthy note, private banks must work on reducing their net NPAs. Citing ICICI Bank as an example, the net NPA ratio declined to 0.9% in Q2FY22 from 1% in Q1FY22. This led to a reduction in provisions by 9% YoY to Rs 2,714 crore. With more liquidity in hand, total advances grew 17% YoY in Q2FY22 to Rs 7.6 lakh crores.

Yes Bank’s recovery in net NPAs in H1FY22 has been Rs 4,280 crore and the target for FY22 is estimated to be around Rs 5,000 crore. If it achieves the target, YES Bank will reduce its slippages a great deal. 

HDFC Bank reported a rise in NPA because provisions for Q1FY22 were as high as 153% of NPAs. In Q2FY22 provisions fell to Rs 3,927 crore from Rs 13,189 crore in Q1FY22. With the recovery in fees income, interest margins, and retail credit growth, HDFC Bank should have stable NPAs in 2HFY22. Asset quality performance for Axis Bank improved, as its Net NPA ratio declined to 1.19% in Q4FY21. With declining slippages from Rs 7,000 crore to Rs 5,000 crore in Q4FY21, FY22 started well for Axis Bank with NPAs going further down to 1.2%. In Q2FY22 Axis Bank’s net NPAs fell further to 1% from 1.2% in Q1FY22.

Higher defaults in sectors like agriculture drag on NPAs

The story for PSUs like Punjab National Bank, and private banks like IndusInd Bank, and YES Bank started with rising defaults in agriculture and corporate credits. As these banks have been lending more to these sectors, net NPAs reached high levels. With lockdowns continuing in the first half of the year collection efficiency was also low.  

In terms of provisioning, big banks like ICICI Bank, State Bank of India and Axis Bank reported up to 31% drop, keeping the asset quality in check. Private banks with higher exposure to micro-finance loans like YES Bank saw a surge in fresh bad loans. Some PSUs like Canara Bank also saw the same trend.

Operating profits still a cause for concern

State Bank of India and ICICI Bank reported a rise in operating profits of 10% and 94% QoQ respectively, for Q2FY22. ICICI Bank’s 94% rise, attributes to a fall in bank provisions to Rs 2,852 crore in Q2FY22.

IDBI Bank’s operating profit fell to Rs 1,114 crore in Q2FY22, compared to Rs 2,537 crore a quarter ago.  In Q2FY21, net profit came in at Rs 1,054 crore. YES Bank believes that their operating profit will be higher than credit cost and they won’t be utilizing any more capital for provisions in upcoming quarters. This is a good sign for YES Bank’s profitability and improving AUM. 

Both public and private banks are seeing a decreasing trend in their operating profits. Kotak Mahindra, Axis Bank, Punjab National Bank, IDBI Bank & YES Bank have negative QoQ growth in terms of operating profit. ICICI Bank shines in this regard as provisions declined by 9% for Q2FY22 which helped increase the operating profits gap by Rs 4,619 crores.  

What is RBI’s role here?

Covid-19 induced a slowdown in the economy. In repercussion, RBI slashed its repo rate to 4% for FY22 to increase liquidity in the financial market. From time to time banks need to borrow funds from RBI to maintain their liquidity flow. Now that lockdown restrictions have eased and markets are opening up, liquidity flow has drastically improved. Industries with net negative growth are showing positive growth and improved earnings for this quarter. This has increased earnings of banks and NPAs to fall.

This fall in NPAs and improvement in assets however, may be short-lived. In a new issue from RBI on the identification of NPAs, RBI asked banks not to classify an NPA as a standard asset merely when they receive payments on interest dues. Simply put, an NPA account can now be classified as standard only when both the principal and interest amount is paid by the borrower. Banks are advised to follow these instructions by December 31, 2021, for new loans. As for existing loans, they can be updated as and when they are due for renewal. 

For now, this is likely to increase the number of bad loans on the books across banks.  This might come as additional stress for banks whose asset quality deteriorated this quarter. RBI on the other hand wants uniformity in reporting across all lending institutions, be it banks or NBFCs. 

With slowness in credit and renewal rates, RBI is being cautious at the first step and wants NPAs to be classified as bad loans on immediate default. It is a wait-and-watch game as to how this ‘caution’ will bear fruits for the banking sector.

Beyond profits and NPAs, banks are the backbone of India’s financial system. With a lot of mergers going on, Q3FY22 will be an interesting quarter to see if the banking sector has held its spine in the chaos. Mergers should help PSU banks to reduce their cost of operations, reduce their NPAs and improve their net interest income growth. Comparing PSUs to private banks, net interest income growth has been faster for PSU banks at 5% compared with 2.1% for the private banks.

Private banks’ credit cost helped them deliver growth in the bottom line and only a few banks like Kotak Mahindra Bank showed a decline in net profits because of an increase in operating expenses. With a delayed or no third wave, the sector should bounce back to better than pre-covid levels of growth.

One important factor that needs to be addressed if we want our banks to go back to normal is to increase their investment in technology. When the pandemic hit we all realized how ingrained technology is in our lives. Right from ordering food, to sending parcels across towns, getting a ride, or getting your monthly ration delivered at home. Everything is at the tip of our fingers. 

Banks now have adequate technologies like net banking to make transactions easier across the country. Fintech companies are increasing pressure on the traditional players in this sector, bringing a Rs 10 transaction to our fingertips. This is something banks should be competing in. UPI transactions have already become an in-thing as they are way ahead of banks in the speed of transactions they offer customers. 

In the coming years, usage of mobile banking is going to surge for both customers and businesses. The way forward would be for banks and fintech to collaborate towards addressing persistent last-mile issues in banking, and making each touchpoint for banking customers easier. Making APIs available to fintech startups, and bringing better tech to both core banking and payments will be critical for banks to win market share in the coming quarters. It is time for banks to adapt, and start investing aggressively in shaping their financial future, rather than just responding to trends.