A senior analyst with a brokerage has reservations about my last week’s column that said one doesn’t need to worry too much about the health of Indian banking industry as bad assets of the industry are not alarmingly high. According to this gentleman, bad assets of Indian banks will grow and they run the risk of part of their exposure to infrastructure sector turning sticky.
He claims that banks so far have been able to stay away from piling bad assets in infrastructure sector by giving fresh loans to group firms or special purpose vehicles floated by corporations which, in turn, are used to service the debt. In banking parlance, this practice is called ever-greening. For obvious reasons, this analyst doesn’t want to be named. “I have discussed this with banks as well as companies but I can’t tell you more on this as I need to do business with them,” he told me.
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Many analysts have started raising red flags on banks’ outstanding loans to the power sector as mounting losses in state electricity boards and delays in execution of new power plants could make recovery difficult. Delays are also seen in roads, ports and other infrastructure projects. Overall, Indian banking industry’s exposure to infrastructure sector doubled in past two years, between May 2009 and May 2011—from Rs2.75 trillion to Rs5.5 trillion, about 14% of the industry’s loan portfolio.
Loans given to power projects account for more than 50% of banks’ overall exposure to the infrastructure sector. Between May 2009 and May 2011, bank loans to power sector more than doubled, from Rs1.3 trillion to Rs2.88 trillion. During this period, banks’ exposure to telecommunications projects rose from Rs47,000 crore to Rs97,700 crore; roads from Rs50,600 crore to Rs98,000 crore and other infrastructure, including ports, from Rs47,000 crore to Rs66,700 crore. While banking industry’s credit growth had been about 17% in fiscal 2010 and a little over 21% in 2011, the industry’s exposure to infrastructure loans grew by at least 40% each of these years.
While a significant rise in the losses of state electricity boards poses risks to banks’ exposure to power sector, delay in project completion is the main reason behind analysts’ worry about the health of loans given to roads, ports and other infrastructure projects. Typically, they are long-term loans and many of them could be as long as 14-15 years. The borrowers enjoy a moratorium on debt servicing but in many cases, apparently even after the moratorium period is over, projects are far from being completed and corporations are not able to start paying back. Even the completed projects are not generating enough cash to pay back bank money.
In such a situation, some of the corporations, I am told, are finding innovative ways to service the debt. They are raising working capital loans through other group firms and using the money to pay project loan instalments. Banks can give money to a subsidiary or a group company of the likely defaulter and this money can come back to the parent company in the form of an inter-corporate deposit which in turn makes the interest payment. Similarly, a bank can also lend money to a company to pay off another bank’s loan.
No company wants to turn defaulter as a default makes the entire group ineligible for bank loans. Given a choice, banks also would not want to pile up bad assets as such assets dent their profitability since they do not earn any interest and, on top of that, they need to set aside money for bad assets.
Quite a few infrastructure loans need to be restructured, analysts are predicting. Once they are recast, corporations will be given more time to pay back and banks won’t need to classify them as bad assets—a win-win situation for both. Loan restructuring is fast becoming a habit for Indian banks and unlike other countries such as Korea, they are not required to make hefty provisions for such recasts.
At his 8ft x 10ft UK representative office on 1 Liverpool Street in London, Sendhil Ramanathan, chief representative of Union Bank of India, is busy these days drawing plans for the bank’s UK subsidiary for which it will soon seek the local regulator’s nod. Axis Bank Ltd, too, is planning for a UK subsidiary. As the impact of the collapse of Lehman Brothers Holdings Inc. recedes, it’s becoming business as usual for Indian banks in the UK.
Under the local banking law, Indian banks cannot have branches in the UK; they need to float subsidiaries. The minimum capital requirement for local incorporation is €6 million (Rs38.9 crore today), but they are encouraged to pump in at least 10 times more in first three years. Both the banks have appointed audit and consulting firm Deloitte to draft business plans. In some sense, such firms are like motor driving schools in Mumbai which not only teach you how to drive, but also ensure that you get your licence.
State Bank of India has the largest asset base in the UK, close to $7 billion (Rs31,220 crore today), followed by ICICI Bank Ltd (about $6.5 billion), Bank of Baroda (about $4.6 billion), Bank of India ($3 billion), Syndicate Bank ($1.5 billion) and Punjab National Bank ($925 million).
Indian banks operate on thin net interest margins in the UK—1% or even less. Compared with high street banks, they pay more both for term deposits as well as savings accounts. Even for inter-bank borrowings, their cost is higher than local banks. And yet they want to be at the global financial centre since they can lend to Indian multinationals across the globe. In London, they can create assets in any currency they choose. Besides, it’s a good training ground for their treasury managers.
Tamal Bandyopadhyay keeps a close eye on all things banking from his perch as Mint’s deputy managing editor in Mumbai. Please email your comments to email@example.com