News analysis

Temasek's return a sign of cautious optimism in India's banks

Hard to say if it was foresight or dumb luck, but Temasek took the right call on Indian lenders when it sold two-fifths of its 3.5 per cent stake in ICICI Bank in February 2012.

In Singapore-dollar terms, and adjusting for a stock split, the Mumbai-based firm's shares have barely budged since. But soured corporate loans, which gutted Indian banks' profits and eroded their capital, are starting to peak. With that, the pall of gloom that had descended on the industry is lifting.

Temasek is wetting its toes once again, taking an US$18 million (S$24 million) position in ICICI Bank's American depositary receipts (ADRs).

Temasek's guarded optimism has company. The benchmark index for Indian banks has risen 39 per cent since the end of February, when government- bond yields began to slide after trading in a narrow range for more than 12 months: The correlation between soaring bank stocks and surging government bond prices is hardly a coincidence.

The fatter the bond trading profit, the higher the opportunity for lenders to clean up their books faster than investors currently assume.

To see how, consider ICICI Bank's treasury income of US$115 million during the last quarter. That's 12 per cent more than the lender earned in the whole of the previous year. State Bank of India booked US$407 million in profit from sales of investments in the three months to June 30, 92 per cent higher than the period ended March 31.

As much as 39 per cent of Bank of Baroda's non-interest income between April and June came from trading gains, versus 16 per cent a year earlier.

In many ways, the bond market-driven improvement in Indian bank shares is reminiscent of the early 2000s. Then, too, a fixed-income rally was a helpful source of profit for lenders struggling to write off bad loans, especially advances made to an overcapacity-plagued metals industry. But lenders can't rely on the bond market alone.

Corporate credit demand remains weak, leaving retail lending as the main source of earnings. And while State Bank of India's non-performing loan pile grew by just US$500 million in the June quarter, compared with a US$3.8 billion build-up in the previous three months, that may be partly because the troubled steel industry is enjoying a high degree of government protection from cheap imports.

In reality, steel mills are neck deep in debt and a sustainable improvement in their repayment capacity might be a ways off.

For now, investors' main expectation from Indian banks is that they might deliver less bad news in future. Or at least that's what Temasek's cautious re-entry appears to suggest.

Still, the industry's average return on equity has collapsed to just 8.6 per cent - dismal in comparison to 13.4 per cent for the MSCI Emerging Market Banks Index. Even if the worst is over for Indian lenders, that gap won't get closed in a hurry.

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A version of this article appeared in the print edition of The Straits Times on August 17, 2016, with the headline 'Temasek's return a sign of cautious optimism in India's banks'. Print Edition | Subscribe