The Indian financial sector i.e. Banks and Financial Institutions that weather the financial crisis very well in the year 2008 are today facing multiple headwinds which are likely to lead to an increase in NPA’s going forward.
First is the traditional risk in lending during times of easy liquidity and lower interest rates which all banks face. As the interest rates move up and liquidity gets squeezed a number of borrowers which would have been standard assets start delaying payments or start defaulting. This cycle is now on for a large number of banks specially the PSU banks which lent very aggressively during the year 2007-2008. These NPA’s are likely to increase going forward as it happens in a normal expansion cycle. As such I would not like to spend too much time on this as this is part of the normal business cycle that banks go through.
Now coming to the specific risks that have come up in the Indian context over the last few days
Exposure of Indian Banks to Microfinance institutions – This risk has come up over the last few weeks as various agencies have started to monitor the working of MFI’s and tying to bring about some regulation into the industry. The current outstanding advances of MFI’s are estimated to be around Rs 20000 crores and bank funding for the same at Rs 12000 crores. This lending that was perceived to be virtually risk free is now turning risky and will need to be monitored going forward.
Exposure to the real estate sector – Bank lending to the real estate sector went up by nearly 7-8 times in the first 7 months of this year, albeit on a low base. The real estate sector has come under regulatory glare due to high real estate prices and teaser schemes. RBI in its credit policy has recognized that some sort of bubble is forming in this sector and put restrictions on how much can be lent for housing loans and increased risk weight ages for high value loans. A large number of banks through their teaser schemes have given loans to client at 8% for the first couple of years and then they will become floating. Some of these loans will start to float from next year where the interest rates are likely to go up by 1.5%-2% for most of the people who have taken such loans. This could create disruptions in interest payments as it will be a steep jump at one shot. Most retail loan seekers do not do such an evaluation while taking a loan and could be hit as and when the reset happens. This could create issues for banks that have been aggressive with such schemes over the last 3 years.
A number of real estate companies have been buying very high priced land and a lot of the funding for this comes from banks. This will also become risky if real estate prices start coming off. The transactions in the residential real estate sector have come off drastically over the last six months. This could create cash flow issues for developers which in turn will risk bank borrowings.
Exposure to the telecom sector – The telecom sector has come under the cloud over the last few days. A large number of license fees as well as 3G and Broadband auctions were funded by banks and Infrastructure finance companies. This could potentially be a bigger source of worry for the financial sector as the amounts involved here are huge. Increase in NPAs from this sector is a certainty going forward and historically this has been one sector that has not defaulted. This can put the balance sheets of some banks and Financial Institutions under severe pressure.
Under the circumstances, this sector that has led the market rally and has been a big outperformer could underperform going forward.
On Markets
Markets have become increasingly volatile over the last few days. The first phase of the sell off due to European concerns, USD strength and poor IIP numbers has materialized. However the strength of the global equity markets has been quite intriguing where European markets have actually held on the best and have virtually seen no correction. The sell of in
I believe that there are two scenarios that can play out now. The first and which is my base case view is that the markets continue their correction and go to a level of around 5500 for the Nifty and 18000 for the Sensex by the middle of December and after that show the next upswing. The second is that the markets bounce back again and go to a new high in December before crashing by 20-25%.
Either ways a correction is imminent and ultimately we are likely to correct down to retest the earlier breakout level of 5400-5500 for the Nifty for the next big upmove to start.