Indian banks’ provisions are expected to almost quadruple in five years as asset quality deteriorates and capital demands increase, according to a report by financial services management consultancy Oliver Wyman and investment bank Morgan Stanley and Co. Inc.
Provisions are expected to rise to Rs75,000 crore by 2013 from Rs20,000 crore in 2008, given “tightening economic conditions and artificially low write-offs in the last five years”, said the report, which predicted a “significant capital shortfall” for Indian lenders.
The adoption of so-called Basel II guidelines may require banks to set aside additional capital to cover the risk of lending and investment. Basel II requires financial institutions to maintain enough cash to cover risks incurred by their operations, with banks holding riskier assets needing to maintain more capital than those with relatively safer portfolios.
The report comes amid upheaval in the global financial industry, which is reeling under liquidity and capital shortages following the US credit crisis that led to the collapse of Bear Stearns Companies Inc. and Lehman Brothers Holdings Inc., the US government takeover of mortgage lenders Fannie Mae and Freddie Mac and the sale of Merrill Lynch and Co. to Bank of America Corp.
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The Indian financial services industry “in the immediate, is in a comparatively robust state and should largely be insulated from adverse global developments”, the Morgan Stanley-Oliver Wyman report said. While problems exist in India, “these are more structural in nature and will take some time to manifest themselves fully”.
Still, India’s banks have their share of problems. The central bank has raised its key interest rate by 125 basis points this fiscal year and increased the proportion of deposits that commercial banks must keep with it by 150 basis points in a move to combat inflation on Monday (though it cut the ratio by 50 basis points).
That has led credit growth to slow and defaults to rise. One basis point is one-hundredth of a percentage point. India’s financial sector has experienced earnings growth of more than 20% per annum over the last five years to generate revenue of $55 billion (Rs2.6 trillion), comparable to Australia and South Korea, in 2008.
“Despite this growth, fundamentals are weak,” the report said, citing comparatively poor efficiency levels despite low labour costs, market fragmentation, insufficient emphasis on productivity and a high level of public sector participation in the market.
“Current average sector valuations do not fully reflect the likely slowdown in earnings and increased capital requirements,” it said. The report predicted that select firms would outperform their peers in the adverse market conditions and will emerge as “lead consolidators for the subsequent structural change involving sector consolidation, ownership changes and business model refinement”.