Having profited from the quick resurgence of corporate borrowing in the first half of 2010, India's banks are heading into trickier seas.
Corporate credit growth so far has been robust, as companies pick up where they left off before the economy slowed down, and launch new investments.
Since March, when banks barely managed to reach the central bank's annual loan growth target of 16%, credit flow has picked up. Loan growth has averaged 19.1% in the new fiscal year. It was particularly heavy in the last two weeks of June, peaking at 21.7%.
Closer scrutiny shows this can't continue. First, the uptick in lending was skewed by loans made to telecom companies, say analysts at Macquarie Research. These loans are related to India's sale of broadband and third-generation wireless spectrums -- in other words, not to be repeated.
There are other reasons corporate lending could slow down. India's central bank has implemented a new base rate rule, which sets a floor below which banks cannot lend.
Consequently, companies, particularly in the short-term, can tap the bond market at lower interest rates than they'd have to pay on a bank loan. After the floor came in effect on July 1, commercial paper issuance doubled from the previous month, according to the central bank.
An added complication for banks is that their chief source of funds – deposits; are growing at a much slower pace than credit. Deposit growth has slowed from 18.1% in mid-March to 14.1% in August. Banks will either have to slow lending, or raise interest rates to lure in more depositors - both options that could hit profits.
All of this comes as India's banks are facing a challenge on a different and wider front. Companies are hungry for foreign capital, in line with their ambition to expand overseas, and foreign banks are eagerly taking up that business. External borrowings by Indian companies rose to $17.85 billion so far in 2010, Dealogic data shows, nearly matching pre-crisis highs.
Meanwhile, the other part of their business - individual borrowers – the local banks are still staying away from after having seen consumer loans sour at a rapid pace during the downturn.
In the stock market, though, the euphoria of the first half of this year hasn't washed away yet. The banking index of Bombay Stock Exchange is up 16.2% since March and close to its all time high. The broader market is up about 4% in the same period.
This implies much smoother sailing than is in store for the banks.