Ample liquidity in the system in 2020-21 resulted in interest rates falling to multi-year lows. The low interest rates also helped banks log handsome treasury gains. Given these factors, the banking sector’s profitability hit a 5-year high in FY21.
The banking sector’s profitability hit a 5-year high in 2020-21 despite it having to grapple with a fresh wave of bad loans in the aftermath of the COVID-19 pandemic, and falling interest rates.
How was this possible?
On average, liquidity surplus, i.e. the money that banks park daily with Reserve Bank of India (RBI) was Rs 4-5 lakh crore in FY21.
Ample liquidity in the system resulted in interest rates falling to multi-year lows. For instance, home loans were offered at interest rates last seen ten years ago. At the same time, low interest rates meant that the cost of funds for banks too fell sharply.
Again, low interest rates also helped banks log handsome treasury gains. When interest rates fall, the value of the existing portfolio of bonds held by banks rise in value. (Bond prices and interest rates have an inverse relationship. When interest rates fall, older bonds become valuable because they fetch the holder a higher rate of interest)
Given these factors, the aggregate net profit of listed banks for FY21 stood at Rs 1,01,621 core as against Rs 7,653 crore the year before.
PAT / (Loss)
Outlook for FY22
One of the weak points in the performance was the steep decline in provision coverage ratio sequentially. This ratio indicates the extent of funds a bank has kept aside to cover loan losses. It fell from 76.6 percent during the December quarter to 69 percent during the March quarter.
This was due to the Supreme Court revoking the interim relief granted earlier to borrowers who had availed the moratorium, and whose accounts could not be declared as non performing assets till the verdict.
Banks also made high write-offs in Q4FY21. The first quarter of FY22 has hurt the banking sector again in terms of lower off-take due to various state restrictions.
Following this, the credit-deposit ratio, the ratio of how much banks lend out of the deposits they have mobilised, stood at 70.8 percent as of June 4, 2021. This is the lowest since February 3, 2017, when it was at the same level of 70.8 percent.
It remains to be seen how profitable banks will be in FY22, as many of them look to strengthen their balance sheet by boosting the provision coverage ratio. This could push up up their cost of funds as they will not be able to onward lend all the money that they raise.
However, banks' credit cost in FY22 is unlikely to be as high as it was in FY21. Credit costs is the amount banks set aside as provisions to factor for some of the loans going bad.