If the apple growers of Kashmir pluck a bumper harvest this year, the credit team of the Jammu & Kashmir Bank (J&K Bank) can claim to have played a small part in it. The bank has disbursed about `8,000 crore as crop loan to orchard owners in the Union territory. According to bank officials, it covers nearly 80% of apple growers in Kashmir. “Apple loans” are a big draw for the J&K Bank. This portfolio has performed well for J&K Bank, much like how the other Apple, the handset manufacturer, has helped grow the consumer loan portfolios of new-generation lenders.
The terrain in which J&K Bank and other old private sector banks (OPBs) operate is very different from that of the new private banks. Banks like J&K Bank, Karur Vysya Bank (KVB), Karnataka Bank, Tamilnad Mercantile Bank, South Indian Bank (SIB), CSB Bank, City Union Bank and Dhanlaxmi Bank exist because of their loyal customer base and not because of their expansive product suites or cutting-edge technology. These banks continue to do the business of accepting deposits and lending the old way with a smattering of technology to keep up with the times. Perhaps, that is a reason why many of these OPBs have stagnated in terms of growth and profitability compared with new-generation private banks. These old banks are capitalstarved, their asset quality is relatively poor and delinquency rates remain at elevated levels, their reach is limited and ownership structure is deeply splintered. In the South, OPBs are stopped from modernising their business by trade unions and the respective communities that set up the banks.
“Low capital base, inadequate use of technology, acute regional focus and an inability to attract good talent are the main problems faced by old private banks,” says PH Ravikumar, chairman, Bharat Financial Inclusion, and one of the founding members of ICICI Bank. While the banking community gloats over the recent merger of HDFC Ltd and HDFC Bank, and picks out a list of probable OPBs that may trigger the next round of consolidation, the senior citizens of Indian banking are not ready to hang up their boots. Most OPBs have long-term plans to keep their businesses running. J&K Bank, South Indian Bank, Dhanlaxmi, KVB and others are trying to raise further rounds of capital to withstand credit shocks and scale up operations.
“We plan to do a follow-on public issue this fiscal to maintain adequate capital buffers and fund our growth plans,” says Baldev Prakash, MD & CEO, J&K Bank, which gets nearly 80% of its business from J&K and Ladakh. “We serve people in the remotest parts of J&K. We have modernised our operations; we do digital loans for salaried people. Our consumer and housing loans portfolios are growing — and now we are trying to get some corporate business by being present in places such as Lucknow, Bengaluru and Mohali,” he adds.
Capital adequacy ratio (CAR) of all OPBs are above the RBI-prescribed limit of 11.5% (including capital buffer) for scheduled commercial banks. CAR is the ratio of a bank’s capital in relation to its risk-weighted assets and current liabilities. Large banks such as HDFC Bank, Kotak and ICICI Bank have CAR in the range of 18-24%, signifying the strength of these banks. But OPBs with comparable CARs do not excite banking sector analysts much.
“CARs of old private banks are stacked perilously on a very narrow base; it can evaporate in no time,” says a banking sector analyst. “Even now, at least 10% of their books are under stress. Their loan books are not well-diversified. The CARs they talk about can thin out very fast when default rates go up,” he adds.
Unlike large, new-gen private sector banks, most old banks do not have long columns of salaried individuals as borrowers. They mostly lend to traders, small businesspersons or MSME owners. Any signs of economic stress can lead to a steep rise in default rates.
“OPBs are unable to raise bulk capital with which they can plan for long-term growth. They are forced to raise small tranches of capital at regular intervals to keep their CARs intact. The mediocre performance of these banks also dissuades investors from investing in them,” says Ravikumar.
They are forced to raise small tranches of capital at regular intervals to keep their CARs intact. The mediocre performance of these banks also dissuades investors from investing in them,” says Ravikumar.
“Such deals may not happen anymore. Fairfax got special permission from RBI, but other PE funds may not get that deal. PEs will not come if they don’t get a substantial chunk of equity,” says another banking analyst.
The leverage ratio — which ensures capital adequacy of banks and sets limits on how much it can leverage on its capital base — of several OPBs is out of whack, at 10-12%. Large new-age private sector banks, in comparison, maintain leverage ratios of 6-8%.
While most OPBs have a pan-India presence, their business is still focused on a specific geographical area. Some bank on certain communities that have been instrumental in setting up these institutions decades ago.
“Some of these banks operate in specific geographies; they have niche customers and have products customised for them. So they do a lot of gold loans, personal loans, MSME or trade finance. Given their relatively higher cost of funding, OPBs are not very competitive lending to larger corporates,” says Krishnan Sitaraman, senior director, CRISIL Ratings.
Take the case of South Indian Bank, which has over 43% of its loan book originating from Kerala. Likewise, CSB Bank draws over 60% of its deposits and disburses 30% of its advances in Kerala. “If OPBs have to register a sharper growth, they need to expand to new geographies and customer segments. But that will be challenging, given the competitive dynamics in the sector. So OPBs may continue to grow at a rate lower than the industry average. Their market share will also not keep pace with the overall growth of the sector,” says Sitaraman.
Most old banks do not have an identifiable promoter, yet they have not been able to shed the old tag of community-focused banks. A few South-based OPBs are still managed by promoter-families, but their shareholding is fragmented. This hampers the agility of banks to take quick decisions or shift growth levers.
“There’s a disinclination among promoters and communities to let the bank be run professionally. This comes in the way of almost all critical decisions that a bank may have to take. In many of these banks, there is no one person “There’s a disinclination among promoters and communities to let the bank be run professionally. This comes in the way of almost all critical decisions that a bank may have to take. In many of these banks, there is no one person.
“It makes very little sense for new-gen private banks to acquire OPBs as they do not have a significant scale. Most new-gen banks already have strong CASA books, branch network, thick capital base, MSME linkages and local customers; so they may not want to take over a legacy bank. Any new bank acquiring an OPB will have to worry about culture alignment and branch overlaps,” says Mukherjee.
Fifteen years ago, acquiring an old private bank would have made sense as RBI put many restrictions on banks getting new branches. But that has changed. The banking regulator allows banks to open new branches in a pre-set ratio that covers metros, urban centres, semi-urban centres and rural areas.
“New-generation banks will take over old banks only if the RBI forces them to do so. Otherwise, they will not take that route. No new-gen bank would want to acquire a legacy lender with a lot of disgruntled employees and trade unions,” says the ED of a mid-sized private bank on the condition of anonymity.
THE WAY FORWARD
Most OPBs are investing in technology to attract young customers. According to analysts, they invest Rs 100-250 crore every year on modernisation. Still, at a functional level, they have not been able to reach the levels of an HDFC Bank or ICICI Bank. “But tech systems at City Union or South Indian Bank are better than many PSU banks,” says an analyst.
Banking sector watchers expect banks like City Union, KVB and CSB Bank to survive longer than the rest. CSB, with Fairfax on board, is trying to change its work culture by hiring a lot of trained professionals. City Union is trying to expand its business geographically; however, the management has yet to lay out a clear succession plan around its key managerial persons. KVB is struggling to grow while Tamilnad Mercantile is still grappling with shareholder issues.
“Bank consolidation involving OPBs looks very difficult at this point in time. These banks have a unique culture which makes integration with new-gen banks difficult,” says Abizer Diwanji, head – financial services, EY India. “OPBs will have to revamp their structure to survive; they will have to gain scale. They will have to start doing business the new way — by collecting data and using them to generate leads. Their work culture needs to undergo a big transformation,” he adds.
Key financial metrics such as return on equity (ROE) or net interest margin are in low single digits for most old banks. ROE for new-gen banks is 12-16% while for most OPBs it is 6-9%. Gross NPA of most OPBs is 6-9%. While headline numbers look good, these banks will have to be on constant vigil as their borrower profiles are presumed to be relatively weak.
“Stress on our books is on account of delays in repayment of corporate loans; but we are very well-covered and adequately capitalised now. Our NPA levels have started to taper down. We’ll trim down our GNPA to 5% in two years,” says Baldev Prakash of J&K Bank. “Our business is growing in double digits; we plan to roll out more retail products (such as gold loans) to get newer customers. The future looks good for us,” he adds. It does for some old banks that may survive for a long time, but not for others that could just fade into oblivion.