In Summary

  • We must all accept the bitter truth that the banking sector is not in very good health.
  • The law introduced last year for capping interest rates will only serve to compound the twin problems of soaring non-performing loans and deteriorating asset quality.

We are in the middle of the season when banks report their annual results and accounts. As we all know, the banking system is a reliable barometer for tracking the performance of the economy.

I have been poring through the annual accounts that have been published so far to see what might be revealed, not only about the state of economic activity, but also look at trends in performance of banks, especially how they have been grappling with interest rate caps.

What picture comes out as you look at the numbers in the published audited accounts of banks for last year? First, non-performing loans are on an upward trend. You will see that even banks reputed to have a high quality portfolio are reporting a spike in bad loans. The ratio of non-performing loans to gross loans is also trending upwards.

The most dramatic is a case where one of the big retail banks that has always been keeping its non-performing loan ratio at a level way below the industry average, has this time around, reported a trebling of bad debts.

Secondly, we have seen the worst case of loan growth demand in decades. Is it just a matter of seasonality in credit demand? No. The phenomenon is most likely a reflection of stressed private sector balance sheets. How are banks responding to the rate-capping regime?

NON-PERFORMING LOANS

We are learning the lesson that when you have high non-performing loans in a controlled interest regime, something has to give. And, what is the most distinguishing feature and trend of the changing conditions? Banks have responded to the rate-capping regime by running away from their core business – taking deposits from customers and lending to businesses – to the lazy option of shovelling all the money into government paper.

When you track the numbers, you will find that the proportion of profit that comes from the core business of intermediation is on a decline. Earnings from investment in government paper, fee income, handling of payments and trading activity are contributing more to revenues and incomes.

In a sense, this should not surprise. Our banks are operating under a regime where prices of inputs are controlled at 70 per cent of the Central Bank Rate, while output prices are capped at four per cent above the CBR.

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