Best of the Breed: That’s the central hiring mandate to HR line managers at bulgebracket investment banks and private equity firms shopping for talent at top business, law and engineering schools. The key assumption behind this elitist practice is that the majority of those coming on board would be high performers, offsetting the cumulative negative impact of the minuscule minority that might fail to measure up to the exacting standards of Wall/Dalal Street. Curiously, this elitism is being extended to India’s commercial banking, as the financial system
seeks to extricate about Rs 10 lakh crore stuck in bad loans
. Lenders now prefer retail borrowers to companies, and the highest-rated businesses in the land to those that come slightly lower down in the pecking order of credit-worthiness. India’s standing as a large consumption economy explains the tilt towards retail. But how will banks manage to fund only 25% of the credit-rated investment grade and above?
This segment is already overbanked as better risk profile, diverse businesses and greater access to funds in India and abroad have helped attract banks toward these behemoths.
The shift toward this higher-rated companies is clear from the investor presentation on the website of top private sector financiers such as ICICI Bank and Axis Bank.
ICICI’s lending to A- and above companies has increased to 66.3% of its loan book in December 2018 from 51.9% in March 2016 even as the loan book has increased to Rs 5.64 lakh crore from Rs 4.35 lakh crore in March 2016.
For Axis Bank, the BB-rated portfolio as a percentage of gross customer assets has come down from a peak of 7.3% in the first quarter of fiscal 2017 to 1.40% in December 2018.
As banks have burnt their fingers in lending to lower rated, fast growing and infrastructure companies, this space is set to get more crowded fetching lower margins.
Safety first, glory if possible
Indeed banks are preparing to sacrifice some profitability in favour of lower credit risk.
“It is a trade-off between higher margins and going for higher-rated loans, which means that the pricing will come down. Banks will have tomake up for this lost income through avenues like other income,” said Sujit Kumar Varma, deputy managing director, corporate accounts group at State Bank of India. The country’s biggest lender is also following its private sector peers in consolidating its wholesale lending toward higher-rated companies. It also means that companies rated lower than BBB will find it difficult to access funds and may have to depend on nonbanking sources.
This is because India’s local corporate bond market is still unreceptive to issuances from companies below AA. Data from Crisil shows that more than 68% of the issues in the local bond market are companies rated AAA as of December 2018, up from just below 65% in fiscal ended 2015.
NBFCs and lower-rated borrowers
Also, with NBFCs facing their own set of issues centred around adequate liquidity, it remains to be seen whether these companies can get funding at all.
Bankers acknowledge that the pivot toward better credit profile could leave some companies behind.
“There may be companies in the Rs 250 crore to Rs 1,000 crore turnover mark that may find it difficult. But these companies, to an extent, are not bankable and getting money back from them is also difficult. I also have no obligation to lend to these companies,” said Rajiv Anand, executive director in charge of wholesale business at Axis Bank. Anand disagreed that the shift toward better credit profiles will in itself impact profitability, instead pointing out that better credit risk could in fact become a driver for better margins in the future.
But bankers also acknowledge that India is among the few countries where credit pricing for top-rated companies has been mispriced. And this shift toward higher-rated securities will further skew the pricing table.
“One of the big challenges in India is the country is mispriced at the top end.For India’s risk rating, the kind of pricing that you get is wafer thin. So you have got to be very selective about building a business at the top end without being a drag from a return on investment standpoint,” said Piyush Gupta, CEO at DBS Bank, which earlier this month opened a domestic banking unit in the country with an aim to target lending to individuals, small and medium enterprises and offer a wider network to large Indian companies, some of whom DBS already banks.
DBS also went through its own NPA crisis in 2011-12 mainly due to loans given to midsized, promoter-led businesses, which depended too much on the government for their revenue.
Gupta said that in its new avatar, DBS will focus on a mix of high credit and returns to make a profitable business in the country.
Jobs on the line
Analysts say Indian banking is at a crucial crossroads, which could define wholesale banking in the country. “Don’t forget that some CEOs have lost their jobs because of the mistake they made in assessing risks. So bank managements and boards are now sensitive to the risks more than they were before. There is also increased surveillance of end use of funds and credit appraisal. Overall lending has tightened, which is good from the point of view of credit evolution,” said Asutosh Mishra, head of research at Ashika Stock Broking. Mishra said banks also burnt their fingers by lending to lower-rated companies because increased competition had pushed them to lend at rates lower than their credit assessment. “Those were the pre MCLR days when banks could also go below their benchmark rates, which is not possible now. Ultimately, the aim is better credit appraisal,” Mishra said. Bankers said the last decade has forced banks to strengthen their credit appraisal by looking at different metrics, like cash flows. All these will be used in lending to lower-rated companies. “It is not that we will completely stop lending to these companies. We can still analyse their cash flows and lend to companies with whom we have a relationship even if they are rated lower. Banks will have to ultimately develop their own mechanism in assessing credit risk in the long run, which is already happening,” said Varma from SBI. The choices banks make in the next few months are going to change their business for the next decade or so.