Here's why India's biggest banking stocks went nuts today — and what they missed

Here's why India's biggest banking stocks went nuts today — and what they missed
Finance Minister Nirmala Sitharaman (R) announced a 'bank' to resolve non-performing assets (NPA) of the Indian banking sectorIANS
  • India’s leading banks saw their shares price jump by as much as 15% after the Budget 2021-22 announcements on February 1.
  • Finance Minister Nirmala Sitharaman announced the creation of a ‘bad bank’ and an increase of Foreign Direct Investment (FDI) to 74% in the insurance sector.
  • However, experts believe the rally may be short-lived due to the lack of clarity around how the sale of bad assets will work and cost of funding likely to increase.
In a splash of good news for the banking sector, Finance Minister Nirmala Sitharaman announced the formation of a ‘bad bank’ for India during the Budget 2021-22 — even though she never did use those words.

“An Asset Reconstruction Company (ARC) and Asset Management Company (AMC) would be set up to consolidate and take over the existing stressed debt and the manage and dispose of assets to Alternative Investment Funds (AIF) and other potential investors for eventual value realisation,” said the Finance Minister in Parliament.

After the announcement, the share prices of Indian banking stocks went into a frenzy. IndusInd Bank was leading the pack as it went up by 15% to ₹981.40 per share, at its peak. ICICI Bank was a close runner up with a jump of more than 13%.

Increase in the share price of leading Indian banks after budget announcements:
BankIncrease in share price*
IndusInd Bank15.14%
ICICI Bank13.36%
RBL Bank11.37%
Bank of Baroda8.89%
Axis Bank7.71%
Punjab National Bank7.20%
HDFC Bank6.44%
Kotak Bank5.55%
Source: NSE *Closing prices on February 1

While the uptake in banks looks like it was due to the budget, they’ve also benefited from a rally in the Asian markets.

Furthermore, setting up a bad bank to get rid of non-performing assets (NPAs) is only one part of the story. Sitharaman also raised the cap on the percentage of Foreign Direct Investment (FDI) in insurance companies from 49% to 74%. Since most banks have stakes in insurance companies, they are due for a possible windfall to a foreign investor.

What is a bad bank?
An ARC and AMC combination will address the threat of another cycle of bad loans that are sure to come as an after-effect of the COVID-19 crisis, according to Sitharaman.

The ARC will be responsible for resolution under which an independent AMC is likely to focus on asset turnaround, job creation and protection.

However, the structure of how this will function isn’t clear. Experts worry that with an option of selling assets, banks will be more lax on asset recovery. Borrowers too could get bolder about lapsing payments.

The question of a moral hazard
“We are waiting for a lot of clarity there on that particular step. We need to see whether there can be better private participation and to what extent. If it’s a purely government organisation, the question of moral hazard remains really significant in the context of an ARC or a bad bank,” Siddharth Sanyal from Bandhan Bank told Business Insider.

If there isn’t too much private sector participation, the question remains opaque on how the formulas are arrived at, how these ‘bad assets’ will be sold, especially in the case of large loans.

The government hasn’t clarified as to who will fund the creation of the AIF. It’s possible that the banks will have to come together and will chip in money for its inception.

“Unfortunately, when you create this kind of structure, the moral hazard is even good debt can then become bad debt. There could be arguments like competitor mismanaged his finances but you’re letting him get away clean by selling his loans to some bad bank. And, you’re allowing him to prosper, then why should I not go through the same route and you give me the same sort of forbearance...,” explained Deepak Shenoy from CapitalMind.

According to Shenoy, this kind of moral hazard — at least in corporate India — has played out negatively more often than not.

Funding is going to get more expensive
The good news around banking stocks however could only be temporary as the cost of funds may rise in 2021-22. “Banks will have to put a lot more money into government securities where they need ₹12 lakh crore of borrowing next year which is substantially higher. This year they had a lot of help from the RBI, next year we may not,” said Shenoy.

According to him the cost of funding may increase by 15-20 basis points in the coming year that may come as a big blow to banks.