Should you invest in PSU Bank Stocks?

Old School.Rusty.Lethargic are some words that people use to describe PSU banks in India. Filled with red-tapism and bureaucratic incompetency, these banks were dying a few years ago. 

Yes in 2017, the infamous NBFC crisis and scams by people like Nirav Modi and Vijay Mallya had shot up the bad loans of these banks.

But now the tables have turned, After years of reporting high levels of non-performing assets, state-owned banks delivered a stellar performance for the fiscal year ended March 2022. These PSU banks(excluding behemoth State Bank of India) tripled their net profit to Rs.42,457 crore from Rs.14,766 crore the previous year. 

Just when the markets are crashing, economies are crumbling, the most looked upon PSU bank stocks are looking good. But, even after they have trebled their profits, investors aren’t paying any heed to them. While, Foreign investors flock to buy the stocks of banks, financial institutions, they have maintained a distance from PSU bank stocks.

Why is it so ? Why not give them a chance for redemption maybe ?

Investors aren’t really interested in the PSU bank stocks because somehow they know that this newfound change in the financials of these companies is mainly because of RBI. So, between 2015-18, Raghuram Rajan, the then governor of RBI, sensed the rot in the balance sheets of these banks and he knew that most of the banks were not able to recover loans from biggie corporates. 

These banks did not want to classify them as NPAs because then they would have to keep aside a part of their profits for provisions, so it was kinda tricky situation. Rajan, under his reign introduced a series of reforms for classifying bad loans, and restructuring them after the norms NPAs of these banks shot up from Rs.3.1 lakh crore in fiscal year 2015, to nearly Rs.10.4 lakh crore in 2018.

The gloomy state of PSU banks was apparent. Their chances of their survival were bleak. That’s when RBI decided to step in and take the charge. It induced a fresh capital of Rs.3.10 lakh crore and decided to merge a few of them to keep the operating costs low. 

Since 2015, it has infused $47 billion of fresh capital into PSBs. Still, we cannot say that these PSBs have enough capital to grow their loan book. As a report by Fitch, equity tier 1 (CET1) ratio of state-owned banks came in at 10.8% in the first half of the fiscal year 2022, significantly lower than that of private banks, at 16.6%.

Don’t be intimidated by the terms. So, you see banks are very important for an economy and whenever there is a crisis in an economy, people start defaulting on their loans and hence banks are at a risk of it, so to avoid these kinds of chaotic situations, banks are mandated to keep a % of their risky loans as capital. So, in case of PSBs, their capital is not enough to help them survive through a shock or an economic downturn. So, this capital infusion would barely help them survive, leave alone the loan growth.

The newfound state of these banks can be due to the government’s help, and these banks aren’t using the capital to cover them up for downturns rather to they are using it to give away more of these risky loans. As per Fitch, “There is a risk that state banks may use their modest capital accretion to support the government's growth agenda, rather than keep it as insulation against losses when unrecognized bad loans start unwinding in FY23," the rating agency says, adding, "

"The risk of losses is high, with the segment's aggregate impaired and special-mention, (those overdue by up to 90 days) loans reported at 18.5% and 14.9%, respectively, for state banks, and 2.8% and 9.3% for private banks as of September 2021.

Clearly, the revenue growth of these PSBs is on the back of risky loans, and investors aren’t liking it. The sarkari nature, bad loans, bureaucracy has stalled the growth of PSBs. Private players with efficient underwriting are thriving and with this kinda attitude it's difficult for PSBs to grow or get the attention of investors.