Most banks and other financial sector entities, state owned and in private sector have announced their Q3 FY 17 earnings. The quarter was highly unusual as it was impacted by the demonetisation move. In spite of the severe cash crunch that impacted both collections and disbursements of the non-banks, many weathered the challenging environment quite smartly. Some of the banks showed an improvement in their asset quality and earnings profile. More efficient banks have used the rise in treasury income well by boosting their provision coverage ratios. This cautious approach will help them in the coming quarters when the buffer of treasury gains will no longer be there due to stable government bond yields. Even though banks have reduced their lending rates significantly, Net Interest Margins (NIMs) for some of them have not been adversely impacted as they had the benefit of sharply lower term deposit rates. The more retail franchises amongst banks had a bonanza in being flooded with low cost Current and Savings Account (CASA) deposits, some of which will remain with them even after remonetisation.
The recent monetary policy’s change of stance from accommodative to neutral will start distinguishing banks much earlier than anticipated. Over the past year, each bank reported large treasury gains due to a one way drop in yields. Q4 FY 17 will see a sharp reversal in that and going forward, effective Q1 FY 18, banks will no longer be able to count on trading gains from long duration bonds. In that scenario, banks with better quality of earnings i.e. higher growth in net interest income will be able to report profits. Many banks that have reported profits in Q3 would have shown losses without these treasury gains. Non-Banking Financial Companies (NBFCs) will also see a rise in their cost of market borrowings and will therefore be a bit less competitive as compared to banks.
The recent relaxations in regulatory guidelines allowing banks to utilise statutory reserves on their balance sheets to pay coupons on AT1 bonds would immensely help banks in raising this important source of tier 1 capital without which the monetary policy impact on AT1 bond yields would have been much more severe. The possibility of any well-run bank skipping coupons in this category is now quite remote.