Global banking

The world is facing the worst economic crisis since the Great Depression in 1930s. Effects of the crisis have spread far and wide due to excessive debt, deflationary conditions, financial closures and unjustified money hoarding. The financial crisis turned unwieldy with the collapse of the US subprime mortgage segment in September 2008 and its turbulence has severely weakened global financial institutions and markets. The upheaval in the credit market and its consequent fall out has left large global banks in the midst of financial duress. Economic conditions worsened as growth decelerated and inflation rates toughened in advanced economies. The US economy, in particular, has been severely hit by the subprime mortgage fiasco.

In FY09, many major banks in the developed markets recorded drop in profit due to decline in operating margins. Among the developed market banks, Japan’s Mitsubishi UFJ Financial reported sharp decline in both revenue and profit. Banks in other countries too experienced a negative impact on their bottom line — National Australia Bank, Australia; Sberbank, Russia, and Erste Bank, Austria. On the other hand, many top banks in China (ICBC) and Brazil (Banco do Brasil) saw strong growth in sales and profit, while SBI Group, one of India’s largest public sector banks, recorded marginal dip of 2.1% in revenue and 4.5% in profit. The bank’s revenue dropped from USD 22.63 bn to USD 22.14 bn and profit slipped from USD 2.23 bn to USD 2.13 bn.

The chart below compares total bank assets (in USD) to GDP (in USD). Total assets of the top banks in the UK and Singapore—Royal Bank of Scotland and DBS Group—form more than 100% of their respective economy’s GDP. We compare the advanced economy banks with those in the emerging markets such as India, Russia, and Indonesia where total assets of top banks—State Bank of India Group, Sberbank, Bank Mandiri—form approximately 20% of their respective economy’s GDP. The chart indicates the reason for the relatively lower impact of the crisis on these banks but also signifies the need for consolidation and creation of a big entity to fund large transactions commensurate with the elevated economic activity in these geographies.

Financial Stability Indicators – Global Comparison

After passing through a distressing time during the global economic crisis, the global banking system is showing signs of improvement with gradual economic recovery. According to IMF – Global Financial Stability Report 2010, the estimated write-downs by global banks declined to USD 2.3 trillion as of April 2010 versus USD 2.8 trillion in October 2009. In this section, we conduct a comparative analysis between Indian banks and their global counterparts based on key financial stability indicators such as ROA, ROE, CRAR, and NPL-toloans and provision-to-NPL ratios. Some major countries in the emerging and advanced regions have been considered for this analysis.

Capital to Risk (Weighted) Assets Ratio

CRAR (Capital to Risk Weighted Assets Ratio) indicates the stability and efficiency of a bank. In FY09, the advanced economy banks recorded CRAR of 10.3-16.5%, while that for the developing country banks varied between 10% and 20.9%. Within our set of countries, China reported the lowest CRAR of 10%, a decline from 12% in FY08. Russia, on the other hand, maintained a CRAR of 20.9%, followed by Brazil at a higher CRAR of 18.2%. Indian banks recorded a healthy CRAR of 13.2% in FY09, well above the Basel II requirement of 9%, as directed by RBI. CRAR of the Indian banks was at par with that of the developed countries such as the US and the UK. This implies that the Indian banking system is adequately positioned to absorb credit, liquidity, and market risks and maintains capital in excess of the minimum statutory requirement.

Return on assets

ROA is a pure measure of analyzing a bank’s efficiency in managing its assets. In FY09, ROA of banks in the advanced economies was between -0.1% and 0.6%, but that of the developing economy banks was between 0.7% and 2.6%. Among the developed economies, the UK recorded negative ROA, and the US and Japan registered a marginal ROA of 0.1% and 0.2% respectively.

The global financial crisis caused massive turbulence in the developed nations, severely affecting their banking system. Although the developing countries were not exactly insulated from the crisis, they were relatively less affected. Among the emerging economy banks, Brazilian and Russian banks saw a sharp decline in ROA to 1.2% and 0.7% respectively. Both the countries have traditionally reported ROA of approximately 2.5-3%. Indonesia, on the other hand, maintained ROA at 2.6%; Indian banks too recorded a steady ROA of 1%, while Chinese banks recorded an improved ROA at 1.1% in FY09 (from 1% in FY08).

NPL to total loans

Non-performing loans (NPL) to total loans is a major banking stability indicator. Most of the banks saw NPLto- total loans rise in the past two years with increased bad debts in the wake of the global financial crisis. In our set of countries, Russia recorded the highest NPL ratio of 9.6% in FY09, a jump from 3.8% in FY08. Being the epicenter of the crisis, the US reported 5.4%. Among the developed countries, Australia recorded the most comfortable level of 1.1%.

While the developed countries reeled under the rising debt situation, countries such as India and China were successful in combating the bad debt problem with efficient and adequate risk management practices. The NPL ratio of Indian and Chinese banks remained at 2.4% and 3.8% respectively.

The NPL ratio of Indian banks, which had been consistently decreasing from 2004, remained stagnant at around 2.4 over 2007-2009.

Return on Equity (ROE)

ROE measures the efficiency of banks in re-investing earnings to generate profit; the ratio is defined as net profit after tax to total equity capital, and therefore, is used as an alternative measure of profitability. The combination of higher ROA and higher utilization of capital improves RoE.

In line with ROA, ROE too was higher for the emerging economy banks as against the advanced countries (UK and US: -2% and 0.9% respectively as of FY09). Among the emerging countries considered in our universe, ROE was the highest for Indonesian banks at 35.9%. With the impact of the crisis being comparatively negligible, Indian banks maintained ROE at 12.5% in FY09, while the Russian banks saw a drop to 4.9% (from 13.3% in FY08).

Provisions to NPL

The provisions to NPL ratio indicate the strength of a bank in the wake of loan defaults. Banks in the emerging economies recorded higher provisions-to-NPL ratio than those in the advanced countries. The ratio was much higher for Brazil and China at approximately 156% and 155% respectively, and much lower for the advanced economy banks (30.1% and 58.1% for the UK and US respectively). This was commensurate with the lower ROE levels of the banks.