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Why banking sector profits are at record levels despite the pandemic

PSU banks have made large gains from their bond portfolios

bank-desk-india-banking-service-shut File photo | Shutterstock

It has been a tough year across industries as COVID-19 and nationwide lockdowns left a huge impact on businesses. Yet, in a pandemic year, banks seemed to have bucked the trend, raking in profits of over Rs 1 lakh crore. State-owned banks, which in the previous few years were saddled with a mountain of bad loans, saw a profit of almost Rs 33,000 crore in the year ended March 2021, the first profit for all PSU banks cumulatively in the last five fiscal years.

What drove this huge profit growth even as the COVID-19 pandemic led to a sharp fall in India’s economic growth?

Last year, the Reserve Bank cut its benchmark Repo rate sharply to 4 per cent and the reverse repo rate to 3.35 per cent. The interest rate cut was part of a wider stimulus to support the economy hit by the pandemic. But, falling interest rates also brought in windfall gains for banks as trading profits on their bond portfolios rose substantially.

According to a recent report by ratings agency ICRA, PSU lenders booked profits of Rs 31,600 crore due to gains on bond portfolios. This helped them report a net profit of Rs 32,848 crore in 2020-21, compared with a loss of Rs 38,907 crore in the previous financial year.

Private banks too benefited from the gains in trading profits on their bond portfolios. Data from ICRA shows, private banks had trading profits of Rs 18,400 crore last year.

What one must understand is that bond prices and interest rates have an inverse relationship. Bonds offer a fixed rate of interest. When interest rates fall, the demand for bonds that were issued earlier at higher rates would rise, thus driving up their prices. Similarly, when interest rates rise, the rate offered by a particular bond may no longer look attractive and thus its demand and price will fall.

Last year, banks reaped the benefits as interest rates fell sharply. There were other drivers too.

As the number of non-performing assets reduced, particularly related to the legacy accounts, banks have reduced their provisions for the same too. State Bank of India’s provisions for NPAs in 2020-21 stood at Rs 27,244 crore, sharply lower than the Rs 42,776 crore it provided for in the previous year. SBI reported a standalone net profit last year of Rs 20,410 crore, versus Rs 14,488 crore in 2019-20.

The standalone net profit of the country’s largest private lender HDFC Bank in 2020-21 stood at Rs 31,116 crore, compared with a year-ago profit of Rs 26,257 crore.

For much of last year, even as interest rates fell sharply, the overall credit demand remained subdued due to the COVID pandemic, while deposits grew in double digits. So, liquidity in the banking system was abundant.

The overall credit in the banking system has moderated from 6.1 per cent in the quarter ended March 2020 to 5.6 per cent in the quarter ended March 2021. 

Also, even as RBI has slashed interest rates, the transmission of the same has not been to the same extent and is uneven, especially, for the existing borrowers. Weighted average lending rates on fresh rupee loans declined by 159 basis points for PSBs and 158 bps for private banks between April 2019 and April 2021, compared with the 200 bps reduction in the bank rate for a similar period, as per data from CARE Ratings.

The decline in the weighted average lending rate on outstanding loans has been less pronounced for the same period, with the decline being 111 bps for PSBs and 101 bps for private banks. Deposit rate cuts on the other hand have been sharper. This has had a positive impact on the net interest income of banks.

“If we compare the interest income versus the interest expense, we can identify a discernible pattern, i.e., either the interest income has grown at a faster pace than the interest expense or that the interest income has fallen at a slower level than the interest expense,” noted CARE Ratings.

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