HTML clipboard“Credit cycle + Pension + BASEL III – a drag on ROE”
 Banks ROE to remain depressed in the coming years due to structural problems
 Bank’s ROE contracted 90bps to 15.1% as sharp fall in PSU banks profitability more than offset the impact of improvement in private banks. ROE is likely to remain under pressure driven by (1) continued deterioration of asset quality in the near-term; (2) higher pension costs on expectation of change in current pension assumption; (3) cash infusion to pension fund required to manage the highly underfunded status of pension plan; and (4) increase in equity base to meet higher capital requirement under BASEL III. http://www.bharatbook.com/finance-market-research-reports/indian-banking-industry.html
 
 Indian banking industry entered into a new wave of credit cycle on weakening economy
 Indian banking industry entered into a new wave of credit cycle in FY12 due to weak economic & fiscal scenario (which will prevent govt to come out with another expansionary policy and increases the risk of crowding out of private invts) and persistent trend of high imported inflation (which has made RBI’s stance on tight monetary policy ineffective as it is increasingly hurting growth prospects without necessarily containing “imported” inflation). As a result, gross NPA rose from 2.3% in FY11 to 2.8% in FY12 & restructured assets up from 2.7% in FY11 to 4.9% in FY12. Given our expectation that asset quality will remain under stress in FY13, we forecast banks credit cost to remain at elevated levels in FY13.
 
 ROE of PSU banks to decline due to highly underfunded status of pension fund
 Highly underfunded status of pension fund will negatively influence the ROE of PSU banks in the near-term. According to our estimates, PSU banks have a shortfall of Rs. 65,000 cr in pension fund in FY12, which translates to 20% of networth. Considering large number of employees retiring over the next 4 years, pension outgo is expected to surge in the coming years. Consequently, banks would be required to provide cash into pension fund to meet the liabilities, which in turn would negatively impact bank’s ROE. In addition, the current pension assumptions of PSU banks appear to be aggressive compared with private sector banks. Thus, any correction made to the pension assumption will negatively impact the profitability in the coming years.
 
 ROE of banks with low core equity to fall by 100-200bps on higher equity requirement
 CARE Research estimates domestic banks will be required to raise equity in the range of $40-50bn ($20bn of CET1 + $20-30bn of AT1) over the next six years to meet BASEL III guidelines. Banks ROE is projected to fall by 80-100bps for every 1% increase in core equity ratio, if other things remain constant. Given that most PSU banks core equity ratio is in the range of 6-9%, we believe their ROE is expected to remain under pressure in the range of 100-200bps on account of higher capital requirement. However, banks could increase/decrease their lending/ deposit rate by 15-25 bps, increase fee income or bring in cost efficiency to protect their ROE to fall from the current levels.
 
 SECTION- I CARE Research’s OUTLOOK
 Outlook
 Profitability of banks in FY12 and outlook for medium-term
 Asset quality trend of PSU and Private sector banks in 4QFY12 and outlook for FY13/14
 Credit cost trend in 4QFY12 and near-term outlook
 Trend of NIM in 4QFY12 and outlook for FY13
 Outlook on operating cost (employee + others) of PSU and Private sector banks
 Impact of change in pension assumption on networth and profitability
 Impact analysis of underfunded status of pension fund on PSU and Private banks
 Impact analysis of BASEL III implementation on banks ROE
 CARE research outlook on credit and deposit growth in FY13
 Impact analysis of Nair committee recommendation on priority sector lending
 
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