Irrational exuberance at Bank of Baroda

Bank of Baroda Ltd shares rallied 15.15% on Monday after the government said it will appoint two prominent private sector professionals to lead the bank, apart from announcing Indradhanush, a seven-step revamp plan for state-owned banks.

The seven-step strategy is mostly a repackaging of various announcements on capitalization, bank board bureau and other pronouncements made by the government earlier.

So why did the Bank of Baroda shares rally so much? Well, it’s got a sizable amount of capital, for one. The tier I capital adequacy ratio for Bank of Baroda is at around 9.4% and is expected to improve to 9.8% after government’s capital infusion of around Rs.1,786 crore, which is adequate for now, say analysts, given the tepid credit growth.

Perhaps it is the induction of top honchos from the private sector that has galvanized the market? The government has appointed P.S. Jayakumar, currently managing director and chief executive officer of VBHC Value Homes Pvt. Ltd, as the managing director, and Ravi Venkatesan, an independent director at Infosys, as non-executive chairman.

The new management has a strong background and could have long tenures because they are relatively young. Jayakumar was one of the pioneers who set up retail banking in India and has spent decades at Citi while Venkatesan has held some key positions at Infosys and Microsoft, according to a Morgan Stanley note dated 17 August.

True, it’s possible the new management may bring about efficiency and focus on improving the balance sheet structure. Private sector heads are known to focus on recovery first before increasing lending. Macquarie in research note dated 14 August said, with new chiefs at the helm, they expect a certain degree of “kitchen-sinking” at these banks before they begin afresh.

Analysts say they will also try to strengthen collection mechanisms and credit appraisal systems, bring down costs and increase the retail focus. But that attitude assumes that the public sector management is inefficient and hasn’t tried out these measures. It also does not take into account the culture of a public sector bank, its systems and processes, which will take time to change. Nor does it take into account the handicaps under which public sector banks work.

Stressed assets, which include bad loans plus restructured loans, as a percentage of the loan book remains elevated at around 9.9% for Bank of Baroda. The economic recovery is still very fragile, with incremental stress coming from iron and steel sector, and small and medium enterprises; it will be tough to improve asset quality. Non-food credit growth for all scheduled banks is at a low 9.6%.

Unless the new management goes slow on loan growth, sells a large chunk of troubled loans to asset reconstruction companies or economic recovery gathers pace, bad loans are not going to come down soon. A new management will take a long time to effect radical change and it is by no means certain it will succeed.

The Bank of Baroda stock has run up very sharply in the past one month. Currently, it is trading at around its FY16 book value and factoring in a swift recovery. Perhaps the market is reading too much into the recent changes and setting itself up for disappointment.