Do You Have Fixed Deposits With Public Sector Banks? Read This…   Feb 19, 2016

February 19, 2016
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Do You Have Fixed Deposits With Public Sector Banks? Read This…

When a fool challenges a master, nobody really pays attention to the fool because the intellect of the master is indisputable. However, it becomes a dodgy situation when two well-informed candidates make contradictory statements. These days Finance gurus stand divided on the issue of the health of Indian banking industry. One camp is more optimistic than the other, although none of them deny that Indian banks, especially the Public Sector Banks (PSB), are seriously in hot water.

Camp I-RBI
Speaking at the first banking summit organised by the Confederation of Indian Industry (CII), RBI Governor, Dr. Raghuram Rajan said, “There are some wild claims being made by some financial analysts about the size of the stressed asset problem. This verges on scare-mongering.”

Dr. Rajan has recently been awarded as “the ‘Central Banker of the Year’ by Financial Times. Since 2013, Dr Rajan has been winning the award for the “best Central Bank Governor”, as well as felicitations similar to these by various independent reputed financial magazines. In 2015, ‘Central Banking’ awarded him, and in 2014 ‘Euromoney’ accorded him with another honour.

When a man of such stature talks about the state of asset quality of banks, his observations and claims rarely get challenged. But, recently we have been witnessing “those rare moments”.

Camp II-The Supreme Court
Recently, the honourable Supreme Court questioned the formidability of the Indian banking system. A bench led by Chief Justice T. S. Thakur ordered the RBI to provide all details of defaulters with outstanding loans worth Rs 500 crore each. The Apex Court seeks data for the past 5 years. The lawyer of the RBI conveyed that the Central Bank didn’t have any such list, but that it would be available with the respective banks.

The bench headed by T. S. Thakur literally ticked off RBI making remarks such as, "What business are you doing if you don't have the information?"

The RBI requested to have six weeks’ time to provide the requisite information, which was granted by the Apex Court. This action of the Honourable Supreme Court comes on the backdrop of deteriorating asset quality. Between 2013 and 2015, 29 PSBs wrote off over Rs 1 lakh crore as bad loans. This raised several questions over the risk management processes PSBs follow.

Clarifying the position of the Government, Finance Minister Mr. Arun Jaitley said, “The government is considering steps to ensure recovery of bad loans or Non-Performing Assets (NPAs) of the banks so that the problem can be contained.”

Is the common man refugee?
Now it becomes difficult for the common man to arrive at a conclusion. Neither does he understand the law in great depth nor does he understand the nuances of economics. The Honourable Supreme Court is one of the pillars of the Indian democracy, while the RBI has served this nation relentlessly for years and enjoys a good reputation all over the globe. So it isn’t surprising to find you are likely to be confused and a bit worried, when you find them at opposite ends of the field.

One more shade to the debate of bad asset quality of Indian banks
The All India Bank Depositors’ Association (AIBDA) has been seeking assurance from the RBI for depositors’ interest to be protected. In practice, the Deposit Insurance and Credit Guarantee Corporation guarantees deposits of upto Rs 1 lakh only per depositor. The point AIBDA tried to make was that the perception of citizens is all their deposits with PSBs are guaranteed by the Government.

The RBI Governor assures...
“Some citizens are outraged by the size of the losses that will have to eventually be absorbed and want the perpetrators to be brought to justice. Let me emphasize that all NPAs are not because of malfeasance. Indeed, most are not. Loans can go bad even if the promoter has the best intent and banks do the fullest due diligence before sanctioning. Nevertheless, where there is evidence of malfeasance by the promoter, it is extremely important that the full force of the law is brought against him, even while banks make every effort to put the project, and the workers who depend on it, back on track. This is why we have strengthened the fraud detection and monitoring mechanism, and look forward to bank support to make it effective.”

How do we define a willful defaulter?
Instead of restricting to the definition of ‘willful defaulter’ try to understand what makes a defaulter a willful defaulter. When a person has the capacity to pay, but doesn’t honour the repayment commitments, he/she is treated as a willful defaulter. Just in the same manner, he /she is treated when he/she doesn’t utilise the funds for reasons it was borrowed for. Similarly, disposal or removal of collaterals, siphoning of funds, and cooking up accounts allows a bank to classify a defaulter as a willful defaulter.

How will ownership of the bank play a role?
When you have competent people at the top, governance of the entire organisation improves as the same the corporate culture flows from top-bottom. Since the Government holds the controlling stake in all PSBs, it reserves the right to appoint the top brass. This leaves a lot of room for mismanagement.

The Government is formed by one or more political parties having one “party” agenda to serve besides running the Government. Many a times, risk management and sound banking practices get sidelined by the politically-motivated decisions of governments, irrespective of which political party forms it.

Peep through the PersonalFN lens now...
There’s a merit in the argument if someone says, NPAs are not always a result of the unscrupulous actions of PSB officials. Decision making and risk management plays an important role in keeping NPAs under tight check. PersonalFN believes this time the issue of NPAs has got more to do with the structure of shareholding of banks and voting rights. Agreed, the sole motive of public sector banks is not to make profits. But for the bank to sustain without Government bailouts in the long term, it is important to remain adequately capitalised and profitable.

Why should the Government listen to experts rather than playing to its own whims and fancies?
The PJ Nayak commission had submitted a report suggesting that the Government distance itself from a number of governance related functions. Furthermore, it advocated that the Government should transfer its stake in all banks to a company, Bank Investment Company (BIC), promising it autonomy. As the committee report mentions, “The Government and BIC should sign a shareholder agreement which assures BIC of its autonomy and sets its objective in terms of financial returns from the banks it controls”.

The G. Gopalakrishna committee report on “Capacity Building in banks” has made some unique recommendations such as the creation of a position of Chief Learning Officer in banks and improvement of the risk management processes through training and other HR initiatives.

Let’s understand that...
Loans, especially the big industrial ones, don’t turn bad overnight. NPAs are loans (assets of banks) that cease to generate income for the bank for a period of more than 90 days. Mindless lending in boom pricks the bubble of overconfidence in bad times.

As pointed out by Dr Rajan, very few loans may indeed be defaulted willfully. However, no one can deny the fact that it is a grave scenario, as banks are still reporting bad loans and making provisions to cover them.

What’s the real worry?
Although there is a good intent, there hasn’t been any concrete action by the Government as yet. The Government hasn’t advanced much on the divestment of its stake in various PSBs. Implementation of the PJ Nayak Committee recommendation would require some difficult, tough changes to the legal framework including repealing of the Bank nationalization Act (1970, 1980) and SBI Act, SBI subsidiaries Act.

The Government has not yet been able to get GST through; but thinking about such drastic reforms is too farfetched at this point in time. There’s no convincing proof to show that the Government has stopped meddling in governance related issues. The Bankruptcy bill is yet to be passed by the Rajya Sabha—a bill that would make it easy to wind up bankrupt companies within 180 days. Such dilly-dallying and lack of political consensus on issues that are imperative to the nation’s development are the real culprits.

PersonalFN believes the RBI has helped banks distinguish between defaulters and willful defaulters. As a second step, the Central Bank has empowered banks restructure NPAs and has adequately empowered them to deal with bad loans. Therefore, it gives enough reasons to say that the RBI is moving in the right direction albeit at a slower pace. But what worries the common man is the silence of our honourable Prime Minister. He speaks vociferously at a political campaign, and vocal while claiming the achievements such as Jan Dhan. There’s absolutely nothing unusual about that. But why is this vigour absent when dealing with critical issues such as bad loans?

Repealing these acts are more difficult than it appears. There’s not just the opposition, there are trade unions to deal with too. Transfers of employees (which are done mechanically, more often than not), inadequacy of staff, lack of training, and lapses in risk management processes are some issues that require urgent attention. The difference in the remuneration of top officials of private sector banks vis-à-vis PSB top officials speaks volumes. Remunerations in PSBs should be more in line with performance, and appointments shouldn’t be done at the discretion of the Government.

What can a depositor expect?
How many times have the state run banks defaulted on the repayment of your deposits in the past? So, after considering all the difficulties they are going through, the fear of losing money parked with them seems to be slightly unfounded.

If the tendency of compromising on the governance of banks to run the political agenda has brought PSBs to this level of misery, the tendency of politicos to maintain their “clean” social image may always safeguard you against any defaults on your deposits by PSBs.

But unless PSBs start functioning well, achieving awe-inspiring economic growth may not be possible. They are the ones who disburse large ticket-size loans. They still command higher market share as compared to private sector banks. Let’s understand that private sector banks, many a times, restrict themselves to the retail segment and go slow on industrial loans. This helps them stay ahead of the competition. Moreover, they are not subject to political interference and don’t have to respond to RTIs either.

It won’t be unfair if PSBs ask for a level playing field. The Government has to take bold steps and act now, instead of sitting back and simply being spectators to the RBI battling several fronts.

You may not have to worry as a depositor; but you may feel disgusted as a tax payer. At the end of the day, its tax payers’ money that allows the Government to recapitalise PSBs. The Governments take taxpayers money for granted, but they can’t take such risks with their vote banks. The fate of PSBs is just like the pendulum of a wall clock.

“Left and Right” keep ticking as per their convenience. Time’s up!

“Mutual funds are subject to market risks.” This is a standard disclaimer that mutual fund companies use in their commercials and other corporate communications. In reality, many novice investors believe that only equity funds are risky and not debt funds. The commission-driven distributors promote debt funds as the substitutes to fixed deposits.

Here’s a revelation...

Debt funds are not risk free. In fact under extreme conditions, debt funds can generate even double-digit losses. Although the interest rate risk is considered to be the most common risk associated with investing in debt funds, the possibility of encountering the credit risk shouldn’t be undermined. Those who are new to these terminologies should read the next few lines carefully.

Debt funds invest in various fixed income securities that carry different interest rates. When the interest rates in an economy go up, the attractiveness of the interest rates offered on earlier securities issued wanes, making it possible for the investors to buy new bonds by paying higher interest. For example, you invested in a bond trading at Rs 100, paying you the coupon of 8.5%. Suppose the interest rates in the economy goes up and an equivalent bond starts paying 8.75%; the value of bond will fall below 100.

But the market price of a traded bond will also fall when the business of the issuer takes a massive hit, so much so that it affects the ability of the issuer to repay investors. In such cases, debt funds stand to lose. As the Net Asset Value of a fund goes down, the value of your investments reduces as well. Residual maturity of a security chiefly decides its interest rate sensitivity; however, there’s no such clear-cut measure to gauge the credit quality. If your fund manager invests aggressively without adequately diversifying investments, the credit risk exposure of the fund may remain high.

Last year, we saw how an experienced fund house, JP Morgan incurred hard losses. Apparently it was blindfolded by the sound credit rating on the securities issued by Amtek Auto. The fund got a nasty blow when it learned about Amtek Auto’s inability to repay.

Although this episode turned out to be a nightmare for investors of two JP Morgan Schemes, it served as an eye-opener for other investors. Taking a serious note of the incident, Securities and Exchange Board of India tightened the noose on mutual funds.

SEBI tweaked the exposure norms for debt funds. The single sector exposure limit has now been slashed from 30% to 25%. Additional exposure limits provided for investing in Housing Finance Companies (HFCs) will be capped at 5% now instead of 10% earlier.

Moreover, the circular of SEBI, dated February 15, 2016, asked Mutual Fund Houses to ensure that total exposure of debt schemes of mutual funds in a group (excluding investments in securities issued by Public Sector Units, Public Financial Institutions and Public Sector Banks) shall not exceed 20% of the net assets of the scheme. Such investment limitations may be extended to 25% of the net assets of the scheme with the prior approval of the Board of Trustees.

Although the SEBI directive will result in better risk management, it may not be enough to make any significant difference. Exposure of 20% to a financially weak group is high enough to knock down investors.

At PersonalFN, we are opposed to the idea of investing in substandard bonds for higher yields. We believe good quality funds carrying relatively stable portfolios generate consistent returns. Those with sound risk management processes get better rating. In case you are unsure of the debt funds you should invest in, be sure try out DebtSelect, an unbiased research report service of PersonalFN.

Soccer is one of the most exciting team games. Be it a club championship final or UEFA Champions League final, high-voltage games always electrify spectators. But players on field can’t get carried away in the excitement of the game. They always have to play as per the game plan and keep the rules in mind. Every player is given a role and has to do total justice with it, if the team has to win the game. Have you seen any Offense midfield player replacing a Center-back player in the same game? His job is to strike a goal and not defend it. Supposing the attackers and central-forward strikers aren’t playing their roles well, would you replace them with centre back or full back defenders? If any captain does so, that would be disastrous for the team.

When it comes to investing, people seem to be shunning the common sense of not engaging defenders in the role of offenders. The year 2015 wasn’t a good year for equity investors, markets had failed to generate positive returns and meet expectations. Initially, investors ignored the fallacies in the markets and continued buying; however, the protracted lull only increased anxiety levels of the investors.

Looking at the net inflows in income funds (debt funds) of over Rs 15,000 crore in January 2016, it seems that now investors have started going slow on equity funds and have been betting on income funds instead. The weakening of trend in equity and sudden rise in debt fund inflows suggests that investors have been trying to “time” market movements.

Are investors replacing equity funds with debt funds?

Are investors replacing equity funds with debt funds?
(Source: AMFI, PersonalFN Research)

The data indicates that equity markets are losing ground.

But should you be worried?
When poor returns generated by equity funds sadden you, replacing it with debt funds, is probably be the worst thing you could do to your portfolio. If team spirit and well-matched individual roles play a crucial part in a team winning the match; the right portfolio composition is important to generate superior returns.

For mutual funds, there’s no real loss of business. If the inflows in equity funds have started drying up, investors have found a new love interest in debt funds. But from the investor’s perspective, fools go where angels fear to tread.

To ready more about this story and PersonalFN’s views over it, please click here.

Financial Year (FY) 2015-16 which will end in next 1 ½ months, is unlikely to be an exciting one for investors. While equity markets haven’t generated exciting returns so far, fixed deposit rates have been coming down and are expected to go further down. There’s been a lull in the real estate markets across top cities and returns generated by gold haven’t been extraordinary either.

In such an environment, over 5 crore Indians are going to get a reason to smile. Their investment in Employee’s Provident Fund (EPF) is likely to fetch them higher returns this fiscal than what they earned every year for last 4 years.

To ready more about this story and PersonalFN’s views over it, please click here.

Coupon Rate: A coupon rate is the yield paid by a fixed income security. A fixed income security's coupon rate is simply just the annual coupon payments paid by the issuer relative to the bond's face or par value. The coupon rate is the yield the bond paid on its issue date. This yield, however, will change as the value of the bond changes, thus giving the bond's yield to maturity.
(Source: Investopedia)
Quote : “Bull-markets are born on pessimism, grow on skepticism, mature on optimism and die on euphoria.”
Sir John Templeton


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