Banks have churned out strong earnings for the quarter ended March 31, boosted by high demand for loans, even as interest rates are galloping up. But a close look at the numbers will present an interesting picture.

A group of three dozen banks, which have announced financial numbers for the last quarter, have together grown their net profit by 29 per cent over the year-ago period – the highest in the past five quarters – boosted by lower provisioning.

On the one hand, it’s a positive sign, as it shows declining status of non-performing assets. However, analysts will be watching out for better operational numbers, as it will be difficult for banks to drub down provisions beyond a point. If loan growth slows down, as is expected due to high interest rate regime, it can start pinching the banks’ topline growth, as well as the bottom line.

What is worrying is that operating profit growth has dropped to the lowest level in the same period, growing just 13 per cent. The numbers show that for the first time in the past five quarters, year-on-year growth of aggregate operating expenses has outpaced total income growth. This essentially means operating margins are shrinking for banks, partly due to losses in treasury income as interest rates rise and bond prices fall, as also due to higher employee costs.

Signs of stress on profitability are also visible in sequential performance. Sequential operating profit was flat for the same set of 36 banks, over the third quarter ended December 31, 2010, compared to 9 per cent growth in Q3 FY11 over Q2 FY11. Sequential net profit growth also decelerated sharply to just 1 per cent, compared to 13 per cent in Q3, in what may be an indication of earnings growth peaking out for the near term.

Analysts and brokerages have been positive on banking stocks as they see net interest income growing faster than what they have factored in their expectations. This can well be the case, but if lending slows down with companies temporarily postponing investments due to high borrowing costs and consumers tone down their appetite for new cars and fancy apartments, the tide can fast turn for the worse.

Private Banks Faring Better?

Although the big picture remains the same for both public sector and private banks, the negative impact on the operating margins of private banks is relatively muted.

The net profit of private banks rose by as much as 38 per cent, second best only to their cumulative performance in Q4 FY’10 over the fourth quarter of FY’09 – a particularly bad quarter for most Indian companies. This rise in earnings was largely due to a sharp cut in provisioning as bad loans or risky asset class finance shrank. Operating profit grew 13 per cent, just a shade lower than the performance in the previous quarter.

Lower provisioning has been supporting higher net profit for private banks for all of the past five quarters, but in the last three quarters, it has become especially critical for earnings growth. This is because private banks’ operating expenses have sped faster than total income growth as declining treasury income has shaved off some of the growth in loans – thus putting pressure on operating margins.

For instance, ICICI Bank reported strong net profit growth of 44 per cent for the fourth quarter on a standalone basis. This was despite its operating profit dropping 3.9 per cent as higher employee cost and lower other income led to slower growth in total income, compared to operating expenses.

But net profit was propped up by lower provisions and contingencies which declined over 60 per cent for the quarter.

HDFC Bank managed a better show with operating profit rising 23.8 per cent over the year-ago period, lower than the previous quarter but still clocking a growth. It also managed a much lower rise in employee cost compared to ICICI and also churned out higher other income, thanks to more fee income. The bank maintained its net profit growth to 33 per cent, the same level as the past four quarters.

Among other large private banks, Axis also grew its operating profit, thanks to higher fee income, even as its net interest margin was squeezed. Its net profit growth shrank marginally, partly due to higher provisioning on a year-on-year basis.

Kotak Mahindra Bank’s standalone net profit growth was also the slowest year-on-year increase in the past four quarters. Better asset quality allowed it to bring in some funds into the account as against provisioning of Rs 127.57 crore in Q4 FY’10.

PSU Banks Take Bigger Hit

The government-controlled banks have taken a bigger hit on operating profit growth even as the net profit growth has just about managed to match the recent performance, backed by lower provisioning.

What has partly made up for the lower profitability is topline growth. At 30 per cent increase, total income growth was marginally higher than even private banks, even as their interest income growth lagged behind that of their private sector peers.

Among the larger PSU banks, Punjab National Bank’s net profit rose by a modest 5.8 per cent, largely due to higher operating expenses as employee-related costs jumped 72 per cent. Higher provisioning also impacted net profit growth which was marginally lower than operating profit increase, even as total income growth was robust at 31 per cent.

Canara Bank, on the other hand, reported a strong 78.7 per cent rise in earnings backed by lower provisioning and strong total income growth. For Bank of India, a lower provisioning only partly made up for a decline in operating profit. Its net profit growth skidded to 15 per cent from high double-digit growth in the previous two quarters.

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