Analysis

Kiran Dhavale

BoB's merger with Vijaya Bank and Dena Bank will result in the creation of the third largest lender in India boasting an advances and deposits market share of 7 per cent and 7.3 per cent, respectively.

The bank is undertaking process revamping to enhance regulation and boost margins. Its lending practices are undergoing changes in order to curb frauds and bad loans. As such, it is employing a target customer driven approach. 

Bank on Synergistic Gains With Bank of Baroda

Bank of Baroda (BoB) is an Indian international banking and financial services company engaged in personal banking, corporate banking, international banking, small and medium enterprise (SME) banking, rural banking, NRI services and treasury services.

Macroeconomic scenario 

In FY18, the Indian economy experienced structural reforms that led to growth in the formal economy and created new opportunities for long-term sustainable growth. The economy is being formalised on the back of GST implementation, Aadhar, Direct Benefit Transfer (DBT) and digitisation. The government infused a massive sum of Rs 2.11 lakh crore into the public sector banks (PSBs) to tackle the issue of non-performing loans (NPLs) and ease the lending constraints in order to promote growth. The Insolvency and Bankruptcy Code (IBC) also assisted with confronting the issues of NPLs and stressed assets. India jumped 30 places in ranking on 'ease of doing business' in the World Bank’s report 2018. For the first time in 14 years, Moody’s raised the sovereign rating of India. 

Process revamping 

The PSBs have a single flaw in their design, i.e. they are inherently accidentprone. This can be rectified only by making fundamental alterations to the architecture, process controls and culture. Naturally, this makes it even more challenging to curtail frauds and bad loans – two of the biggest nightmares for banking companies. These problems cannot be arrested by merely holding the staff accountable or conducting investigations post occurrence of the frauds. As such, BoB has undertaken monumental steps to redesign its processes and toughen controls and compliances. These include transitioning to a contemporary front-end/back-end decision architecture. All operations with a direct impact on revenues such as account opening, processing and approval of retail loans, forex and trade finance transactions have been centralised. The duties have been compartmentalised assiduously such that branches are engaged in servicing customers, while transaction processing is done at the Shared Services Centre in Gift City, Gandhinagar. The digitisation of processes has facilitated improved transparency and controls. 

BoB has established a special Fraud Risk Management unit, as well as an enterprise fraud risk management system. To mitigate the risk of bad loans, BoB has implemented a new risk-based pricing for retail customers, which has resulted in a sharp improvement in the risk profile. The percentage of customers with a credit bureau score of less that 725 dropped from 19 per cent to 1 per cent, while those with scores above 725 increased from 41 per cent to 63 per cent. This, in conjunction with a strong centralised collections team, has helped the company expand its retail lending. Most PSBs are plagued with the problem of being chosen by the least desirable customers as against the banks themselves seeking the most desirable customers that benefit them. BoB has adopted a target customer-driven approach, which allows it to proactively seek the most desirable customers with distinguished value propositions. The lending practices of BoB witnessed further improvements as the bank established risk-based credit limits. With account plans active in major metro centres covering 80 per cent of corporate credit under the expert scrutiny of relationship managers, two-third of customers rose above the investment grade, up from 44 per cent three years ago. 

Financial Performance

On the standalone quarterly front, the total interest earned stood at Rs 12,078.34 crore in Q2FY19 as against Rs 10,753.33 crore in Q2FY18, registering a growth of 12.32 per cent. The net interest income (NII) increased to Rs 4,492 crore, registering a growth of 20.75 per cent YoY. Net interest margin (NIM) improved to 2.61 per cent in Q2FY19 from 2.34 per cent in Q2FY18. On the international front, NIM rose to 1.66 per cent in Q2FY19 from 1.49 per cent in Q2FY18. EPS climbed to Rs 1.60 in Q2FY19 from Rs 1.54 in Q2FY18, registering a rise of 3.89 per cent. Operating profit before provisions and contingencies stood at Rs 3,081.91 crore in Q2FY19 versus 

Rs 3,041.84 crore in Q2FY18, posting a modest growth of 1.31 per cent. Net profit rose 19.70 per cent to Rs 425.38 crore in Q2FY19 from Rs 355.36 crore in Q2FY18. Net profit margin improved to 3.52 per cent in Q2FY19 from 3.30 per cent in Q2FY18. The yields on advances stood at 3.82 per cent in Q2FY19 as against 2.62 per cent in Q2FY18. The yields on investments stood at 3.26 per cent in Q2FY19 in comparison to 2.79 per cent in Q2FY18. 

Customer revenues were up 19.56 per cent YoY and 4.12 per cent QoQ. On the domestic front, credit growth of 20.37 per cent YoY was witnessed, driven by retail loan growth of 33.55 per cent. Within retail, home and auto loans grew by 39.76 per cent and 38.75 per cent, respectively. The quality of new credit origination improved. Customer income climbed by 19.56 per cent to Rs 5,453 crore, while the core fee income swelled 14.27 per cent. Gross NPAs dropped to 11.78 per cent in Q2FY19 from 12.46 per cent in Q2FY18. Net NPAs declined to 4.86 per cent in Q2FY19 from 5.40 per cent in Q2FY18. The absolute amount of NPAs dropped by Rs 1,325 crore. BoB boasts a provision coverage of 67.21 per cent, which is highest amongst public sector banks. It has a capital adequacy ratio of 11.88 per cent and CET-1 at 9.05 per cent for the quarter ended September 2018, both of which are above regulatory requirements. The consolidated capital adequacy ratio stands at 12.55 per cent. 

On the consolidated annual front, the total interest earned rose to Rs 46,056.42 crore in FY18 from Rs 44,473.44 crore in FY17, posting a growth of 3.55 per cent. Operating profit before provisions and contingencies stood at Rs 13,561.57 crore in FY18 as against Rs 12,464.69 crore in FY17, thereby rising 8.79 per cent. The company reported a net loss of Rs 1,887.10 crore in FY18 as against net profit of Rs 1,814.9 crore in FY17. Consequently, the company reported a negative EPS of Rs 8.17 in FY18 in comparison to an EPS of Rs 7.88 in FY17. 

Key developments


BoB has increased the minimum balance amount by 100 per cent w.e.f February 1, 2019. Savings account holders in urban, metro and semi-urban branches are now required to maintain a minimum of Rs 2,000 in their accounts as against the previous requirement of Rs 1,000. Similarly, the limit for savings accounts in the bank’s rural branches has been increased to Rs 1,000 from Rs 500. These rules may quite possibly extend to the savings accounts in Vijaya Bank and Dena Bank as well, as these have merged with BoB. Failure to maintain the minimum balance amount will invite penalties with an upper limit of Rs 100 for accounts in rural branches and Rs 200 for accounts in semi-urban, urban and metro branches. These fines have remained unchanged. It is important to note that as per the RBI guidelines, savings accounts opened under the Pradhan Mantri Jan Dhan Yojana (PMJDY) and Basic Saving Bank Deposits (BSBD) accounts are exempted from fines levied for non-maintenance of minimum balance. Some banks also exempt students’ account, pensioners’ account and accounts operated by senior citizens from this charge. It is fascinating to learn how much banks benefit from such policies. Based on the data disseminated by the Central government to the Lok Sabha, public sector banks earned a colossal Rs 6,246.44 crore over the past four years by charging their customers for their inability to maintain the stipulated minimum balance in their savings accounts. Over the course of four years, BoB earned Rs 327.89 crore, while Vijaya Bank and Dena Bank collected Rs 4.34 crore and Rs 48.77 crore, respectively. The country’s biggest lender, State Bank of India, collected the highest amount to the tune of Rs 2,893.75 crore. 

BoB has managed to add 23 million customers to its base over a period of 36 months, which has brought its total customer count up to an impressive 78 million! CASA deposits have increased, causing the CASA ratio to escalate by 8 per cent to 41.2 per cent over the period. In FY17-18, retail lending rose by 42 per cent, while corporate lending grew 16 per cent. MSME and agricultural lending also witnessed growth. 

To enhance customer experience, the bank has implemented all the usual technological resources and upgraded internet and mobile banking applications. Its call centre operations have improved more than 93 per cent versus 60 per cent observed earlier. The turnaround time in closing customer complaints has improved with 74 per cent of customer complaints being closed within 7 working days. 

Product innovation has also been given adequate priority as the bank launched new and competitive products across all segments. These include supply chain financing, cash management (Baroda DigiNext), trade finance platformBarodaINSTA (Baroda Integrated Solution for Trade Finance Access), customised products such as gold loans, horticulture loans, wealth management services, educational, mortgage and automotive loans, including commercial vehicle financing. 

Merger between BoB, Vijaya Bank and Dena Bank

As a major step towards consolidation, the Central government declared a merger between BoB, Vijaya Bank and Dena Bank. The merger will result in the creation of the third largest lender in India, boasting market shares of 7 per cent and 7.3 per cent in advances and deposits, respectively. The three banks were chosen because they fit well into the strategy of anchor bank (BoB), good bank (Vijaya Bank) and stressed bank (Dena Bank). While both BOB and Vijaya Bank have reported an improvement in their earnings performance; Dena Bank is under the RBI’s Prompt Corrective Action (PCA) framework and has been restrained from further lending. Thus, the government has wisely chosen the banks so as to ensure that the collective bank does not end up being worse off than the individual entities. When the announcement of the merger was made, it sent the employees and the shareholders of all three banks into a frenzy. Employees lost their sense of job security and contested the share-swap ratio finalised by the banks. Minister of State for Finance, Shiv Pratap Shukla, attempted to allay these concerns in the Rajya Sabha by stating that the government has sanctioned a framework for proposals pertaining to the amalgamation of PSBs through an Alternative Mechanism (AM). This was done with the intention of enabling consolidation among PSBs in order to enhance their strength and competitiveness. The government has reassured the employees of all three banks that no one will lose job as their employment will continue with the amalgamated bank and that their interests will be protected conscientiously. 

Growth drivers

The bank has been aptly christened “India’s International Bank” due to its vast global footprint. It is engaged in discussion with other PSBs with a view to consolidate territories. Moving forward, the bank will focus on the US, UAE and UK while strengthening its relations with Japan and Korea to capitalise on the business opportunities offered by these countries. 

Challenges 

Most PSBs are suffering an erosion in market share owing to the stiff competition from private sector contenders. With most banks already being subjected to Prompt Corrective Action, the deterioration in market share is likely to hasten. This has brought margins and profitability under considerable pressure. To overcome these challenges, PSBs had to scramble to adopt appropriate technology, analytics and expertise. BoB had to reevaluate its international presence in terms of business potential vis-à-vis risk. As such, it withdrew from several countries like Bahrain, Guyana, Bangkok and South Africa. Once the economy revives, credit offtake improves and the issue of NPAs is contained, BoB will be able to enhance its profitability substantially. 

Conclusion 

Owing to the merger, the geographical reach of the bank will expand to bring the total branch count up to 9,489 and strengthen BoB’s presence in the western and southern regions. The combined entity will have a healthy CASA mix of 34.1 per cent as well as a well-diversified loan book. Needless to say, a merger of such a large scale will present its own set of challenges in the near term, especially since the NPL cycle is in the early stages of recovery. However, the relentless purging of bad loans has enhanced transparency and the careful selection of banks will dilute any adverse impact. The bank has exhibited early signs of turnaround in recent quarters. The management’s emphasis on cleaning up the balance sheet and improving provisioning coverage is paving the path for sustainable growth. By virtue of these factors, we recommend our reader investors to HOLD this stock.

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