Banking Crisis: Message from Market Crucial

Banking crisis

Next year would be the 50th year of nationalisation of banks – a major economic policy decision taken by Indira Gandhi in 1969. It was hailed as a progressive decision by many sections of society even though many economists and finance experts had questioned the economic logic of it. Indira Gandhi and those who supported it defended the decision by arguing that these banks were lending only to the rich and not to the broader sections of society and that nationalisation would change this. 49 years after nationalisation, the nationalised banks are in very bad shape by lending money without due diligence.

SBI came into existence in 1955. Fourteen banks were nationalised in 1969 and six more in 1980. Nationalisation of banks led to explosive growth in banking in India benefiting large segments of people. However, political influence and irresponsible lending did irreparable damage to PSU banks. By 1994, mounting NPAs (Non-Performing Asset) completely wiped out the capital of 13 nationalised banks and NPAs touched 24 per cent endangering the very existence of the banking system. PSU banks were back in business only with massive recapitalisation by the government at the expense of the taxpayer. Recapitalisation and the implementation of Narasimham Committee recommendations by the Narasimha Rao Government saved the Indian banking system.

In recent times, the UPA 2 government infused Rs. 60,000 crore as fresh capital in to the PSU banks. In 2015, the Modi Government announced Rs. 70,000 crore of capitalisation, out of which, Rs. 50,000 crore has already been given.

As the NPA problem mounted, in a major recapitalisation drive in October 2017, the government announced a huge infusion of Rs. 1,35,000 crore. In brief, during the last 10 years, the PSU banks have been allocated a massive Rs. 2,65,000 crore.

The market is sending an important message

Market signals are hugely important. Market valuations (market capitalisation) of private sector banks are significantly higher than those of PSU banks. Of course, private sector banks also have NPA issues. But the ratio of NPAs to total loans of PSU banks is three times higher than that of private sector banks.

The market recognises and rewards this superior governance of private banks. The market capitalisation of HDFC Bank (incorporated in 1994) is higher than the combined market capitalisation of all nationalised banks and SBI put together. The market value of Kotak Mahindra Bank (incorporated as a bank in 2003) is equal to the combined market value of all nationalised banks, excluding SBI.

Recently, Kotak Mahindra Bank overtook SBI in market capitalisation. The market cap of the 9-year-old NBFC Bajaj Financial Services is higher than the combined market cap of 14 nationalised banks with decades of history. The market rewards governance and punishes mis-governance.

The shares of 18 nationalised banks are quoting at substantial discount to their book value. Contrast this with the valuation of private sector banks, which are quoting at several multiples of the book value. HDFC is quoting at more than three times the book value and Kotak Mahindra Bank is quoting at six times the book value. The market is rewarding superior governance, management quality and the future growth prospects of these better-managed banks.

The potential

Banking is a play on the economy. As the economy grows, the demand for financial services will grow disproportionally. The best days of Indian banking are yet to come. There is a near consensus that the Indian economy will grow from the present $2.4 trillion to around $7 trillion or more by 2030.

The growth in Indian banking, particularly private sector banking, will be disproportionally higher. The market cap of the Indian banking industry – public and private sector banks put together – is around $ 180 billion. This is less than half of the market cap of the largest US Bank J P Morgan, which has a market cap of $400 billion. This gives an indication of the potential for growth of the Indian banking industry.