Indian banks are afflicted with bad loans. Growth in these accelerated for the fourth successive quarter in January-March 2012, according to the recently released Financial Stability Report of the Reserve Bank of India. Adjusted for provisions, nonperforming assets may have inched just 0.1 points in the six months to end-March (to 1.3%), but the pace at which fresh loans slipped into the red was faster: 2.1% of standard assets at the start of this year were bad by March 2012, up from 1.9% in September 2011.
That’s not all. Add restructured accounts, i.e. loans given temporary reprieve from prudential norms to help tide over a bad spell, and banks’ asset quality risks get compounded. The growth rate of restructured loans jumped to 50% in the first quarter of this year, two and a half times that in October-December 2011. Some of these are bound to eventually turn bad. Historically, almost 15% of restructured loans do so. RBI’s projections based on this number show the NPA ratio will then rise to 3.4%.
Will this trend repeat in the April-June quarter? In January this year, RBI deputy governor Anand Sinha indicated that the January-March quarter was probably the peak for fresh additions to NPAs. For many public sector banks, where the bulk of restructuring is concentrated, restructuring in the fourth quarter of 2011-12 was far larger than the entire year, e.g. Punjab National Bank restructured Rs8,600 crore, more than half the entire Rs15,300 crore for the whole year. And according to RBI’s Systemic Risk Survey, risk perceptions in the financial system ranked asset quality risks second to those from market volatility in April 2012; down from their top position since October 2011.
Does that mean the trough is reached, like some macro variables? That remains to be seen as bad loans respond to the economic cycle with a lag. Certainly, the 30% rise in the volume of debt recast requests in June over March (on quarterly basis) suggests the worst may not yet be over for banks; while all restructuring requests may not get regulatory relief, those from textile firms (Rs35,000 crore according to one estimate) are likely to be examined with a benign eye.
Other than decelerating growth and high interest rates, a key source of stress in bank assets has been tight liquidity, which indeed coincides with the sharp escalation in fresh slippages and restructured bad assets. Another indication it is lack of liquidity rather than a bad asset in itself is the divergence in market prices of stressed assets and their book value; the former exceeds the latter in most of these cases, pointed out Nilesh Shah of Axis Direct in a recent interview with Bloomberg-UTV. An improvement in liquidity conditions may therefore be a relief. Still, the sustained rise in bad assets is consistently squeezing lending by banks, leading to lower credit growth targets and keeping their focus upon asset-liability management and credit monitoring.
Finally, RBI’s stress tests show banks’ risk-adjusted capital remains resilient to extreme credit risk shocks even as some banks would be considerably weakened. Certainly, India is not Greece nor Spain, or even the US and UK as far as banks’ bad assets in relation to capital is concerned. Yet, at around 15%, its NPA to capital ratio compares poorly with comparators like Brazil and China (negative) or Russia (10%) and Indonesia (5%). There is little doubt therefore, about the need to reduce the extent of bad assets and augment banks’ capital.
Renu Kohli is a New Delhi-based macroeconomist; she is a former staff member of the International Monetary Fund and Reserve Bank of India.