Decline in bad loans to improve profitability of banks

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Last Updated13/04/2022

Growth in pre-provision earnings and decline in bad loans will improve profitability of banks in the current fiscal.

Capital ratios at Public Sector Banks (PSBs) have improved in the past year, helped by capital infusions from the government.
The declining trend in bad loans started in 2018.
The gross NPAs of scheduled commercial banks dropped to 6.9 percent as of September 2021.

PSBs as well as their private sector peers have proactively sought to raise capital from the equity capital market.
Rated private sector banks had an asset-weighted average Common Equity Tier 1 (CET1) ratio of 15.8 per cent at the end of 2021, which positively positioned them to grow loans as economic conditions improved.
Improvements in PSBs' financial health will continue to help them raise equity capital from the market & reduce their dependence on capital support from the government.
The gradual increases in domestic interest rates will boost net interest margins.
Funding costs will increase marginally because banks have reduced the share of high-cost corporate term deposits in total deposits.
Stable asset quality and existing provisions against legacy stressed assets will allow banks to reduce loan-loss provisions.

Common equity Tier 1 covers liquid bank holdings such as cash, stock, etc.
The CET1 ratio compares a bank's capital against its assets.
In the event of a crisis, Tier 1 equity is liquidated first.
Many bank stress tests employ Tier 1 capital as a beginning point for determining a bank's liquidity and ability to withstand a difficult monetary event.

The NPL ratios will decline because of recoveries or write-offs of legacy problem loans while formation of new NPLs will be stable as the economy recovers.
Loan growth will help push NPL ratios down by expanding the overall pool of loans.
Improving consumer and business confidence as well as improving domestic demand will support economic growth and credit demand.

India's economy is expected to recover in the next 12-18 months with GDP growing 9.3 per cent in the year ending March 2022 and 8.4 per cent in the following year.
Increasing corporate earnings and easing funding constraints for non-bank finance companies will support loan growth, thus improving the overall financial situation of the country.

Prelims Takeaway

Mains Takeaway

Q. Easing the Financial constraints and allowing Financial institutions to expand their investing is a need for every economy to grow. Analyze.