RBI brings reality dose to bank valuations – Mint

MUMBAI: Central banks are in the job of managing market expectations but seldom do they offer direct comments on equity markets. The Reserve Bank of India (RBI) is no exception and has been at best been sly about valuations in the past.

But breaking away from the norm, the RBI governor Shaktikanta Das has yet again said current valuations do not reflect reality and has even linked it to financial stability. “Stretched valuations of financial assets pose risks to financial stability. Banks and financial intermediaries need to be cognisant of these risks and spillovers in an interconnected financial system,” Das wrote in his foreword for the financial stability report released on Monday.

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The warning was reiterated in another section of the report. “Movements in certain segments of the financial markets are not in sync with the developments in the real sector.”

Have bank shares run off into a territory where they are divorced from the status of the balance sheets? The Nifty Bank index has gained 34% in the last three months and is one of the key drivers of the rise in broader market indices. The Nifty has risen 21.6% during the same period. Clearly, bank stocks have outpaced the broader market despite no clarity on the extent of stress build-up on balance sheets. To be sure, barring a handful of bank shares most are still below their pre-pandemic highs.

These gains are despite the view that the stress on balance sheets has increased due to the pandemic. What’s more is that the full extent of this stress won’t be visible until the judicial standstill on asset recognition goes. That said, a better than expected recovery in loan growth has encouraged investors to drive up valuations. Proactive large provisions by some banks have also helped sentiment.

But the RBI has not just attempted to talk down the equity markets, it has held up a mirror too by way of a health check-up on bank balance sheets. The financial stability report has warned that banks’ bad loans may double by September 2021. The RBI sees gross bad loans account for 13.5% of total loans by September even in a base case scenario. Not only that, the special mention accounts (SMA) that capture incipient risks show that weak borrowers have only gotten worse although stress looks to be contained overall.

Analysts at Jefferies India Pvt Ltd believe that bad loan recognition would begin from the December quarter and gather pace. “From 3QFY21, lenders will begin recognizing NPLs as 4 months have elapsed since the moratorium ended. We expect banks to see 80-100 basis points of loans downgraded to NPLs this quarter,” they wrote in a note.

Shares of banks slipped marginally today, a sign that the RBI’s warnings are being noticed by investors. The RBI has been successful in talking up or talking down the exchange rates when the rupee’s value tended to diverge from fundamentals. It remains to be seen whether equity investors will respond in a similar fashion.

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