RBI brings reality dose to bank valuations

However breaking away from the norm, the RBI governor Shaktikanta Das has but again said current valuations do not reflect reality and has even linked it to financial stability. “Stretched valuations of economic 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.

The warning was reiterated in another part of the report. “Movements in sure segments of the monetary markets usually are not in sync with the developments in the true sector.”

Have bank shares run off into a territory the place they’re divorced from the standing of the stability sheets? The Nifty Bank index has gained 34% within the last three months and is likely one of the key drivers of the rise in broader market indices. The Nifty has risen 21.6% throughout the same period. Clearly, bank shares have outpaced the broader market regardless of no clarity on the extent of stress build-up on stability 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 seen till the judicial standstill on asset recognition goes. That mentioned, a better than expected recovery in loan growth has inspired 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 stability sheets. The monetary stability report has warned that banks’ bad loans could double by September 2021. The RBI sees gross bad loans account for 13.5% of complete loans by September even in a base case scenario. Not only that, the special mention accounts (SMA) that capture incipient risks show that weak debtors have only gotten worse though stress looks to be contained overall.

Analysts at Jefferies India Pvt Ltd consider that bad mortgage recognition would start from the December quarter and gather pace. “From 3QFY21, lenders will start recognizing NPLs as 4 months have elapsed because 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 observed 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 or not equity investors will respond in a similar way.