Mumbai: International credit rating agency Moody’s Investor Services Inc. has sounded a word of caution on the fast retail loan growth of the Indian banking system. In its report “Banking Outlook: India”, released on 11 July, the agency said it is optimistic about the fast growth of the loan rates but there could be some concerns on asset quality over the long term in case there is an economic downturn.
The report also says that though new loans such as personal loans and loans for consumer goods are on the rise, it will take a “full credit cycle” to test the success of such advances for banks. In case of unfavourable economic conditions, this could lead to a lot more delinquencies. But these new loans account for only 8% of India’s gross domestic product (GDP), sharply lower than other Asian economies such as Malaysia and Taiwan, where new loans account for more than 50% of GDP.
The agency also maintains a cautious view on the real value of the security receipts that banks receive in exchange for the bad loans they sell to the Asset Reconstruction Co. of India Ltd (ARCIL).
Currently, banks “sell” bad assets to asset reconstruction companies (ARCs). ARCs buy these assets at a disounted rate but they do not pay upfront for these assets to the banks and instead issue security receipts that are shown as an investment on the books of the bank. ARCIL is a predominant player in this field.
The rating agency says that with the advent of several other players into the field of asset reconstruction, the real value of these security receipts will be revealed once a liquid secondary market for trading bad loans is created in India. The country is still a while away from a junk bond market such as those that exist in developed economies.
The report points out that banks, both in the state sector as well as private players, have done their bit in bringing down the levels of non-performing loans (NPLs) in comparison to their total advances. Gross NPLs to gross loans for all commercial banks in India, according to Moody’s, at the end of March 2006 stood at 3.3% compared with 5.2%, a year earlier.
It also says public sector banks are catching up with peers among new private and foreign banks in bringing down NPLs. This is an indication that public sector banks have bettered their risk management practices.
However, the rating agency views this improvement with “cautious optimism due to the extensive restructuring carried out in recent years across the system, which could indicate that the actual level of NPLs may be higher”.
The challenge before Indian banks, according to Moody’s, is to maintain and even improve asset quality, given the fast loan growth, and also the possibility of a reversal in the economic cycle. It is keeping a close watch on the Indian central bank’s norms with regard to bank exposure to the equity markets and the commercial real estate sector. Though difficult to ascertain at this stage, higher exposure to such sectors could carry “significant hidden risks for banks”, the report says. This is because both the equity and real estate markets have been subject to severe price fluctuations in recent months.