Mumbai: Bad debts of Indian banks rose for the first time in six years in the fiscal year ended March, a report by the Reserve Bank of India (RBI) has said.
As the global crisis can worsen credit risks, banks should have more capital, said an annual publication of the RBI on the trend and progress of banking in the country, released on Wednesday.
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According to the RBI, banks have seen rapid credit growth during the previous three years and some slippage in non-performing assets (NPAs) could therefore be expected. Rising interest rates last few years have also contributed to higher NPAs, it said.
The total amount recovered and written off by banks stood at Rs28,283 crore in 2007-08, higher than Rs26,243 crore in the previous year. But there is nothing to cheer about as Rs34,420 crore worth of fresh NPAs were added during the year, the report said.
What’s more, gross NPAs of commercial banks increased by Rs6,136 crore in FY08, the first such instance since FY02.
“Banks had extended housing loans at floating interest rates. The hardening of interest rates might have made the repayment of loans difficult for some borrowers, resulting in some increase in NPAs in this sector,” said the RBI report.
“The increase in gross NPAs was more noticeable in respect of new private sector and foreign banks, which have been more active in the real estate and housing loans segments,” it added.
According to RBI, a sharp fall in real estate prices will have an adverse effect on the Indian economy and banks must manage their balance sheet risks associated with this in the context of a slowdown.
Bank lending to the real estate sector expanded to 19.3% of total bank credit at end-March, compared with 1.6% at end-March 2004.
If real estate prices rose above what was justified by fundamentals, then too many houses would be built. At some point a correction would set in and asset prices would return to their fundamental levels, the central bank said.
“When this happens, the sharp downward revision of asset prices can lead to a sharp contraction in the economy both directly, through effects on investment, and indirectly, through the effects of reduced household wealth on consumer spending,” it said.
While a broad slowdown and a global financial crisis had sliced off over half the stock market value, RBI said real estate prices had softened slightly in some parts of the country.
Contingent liabilities, or off-balance sheet exposure of banks, increased nearly 88.44% to Rs144.3 trillion in 2007-08 as more companies rushed to hedge their foreign exchange contracts to tide over the volatility in currency markets. This increase is over and above the 80.2% growth seen in 2006-07.
Following the significant rise in contingent liabilities, the off-balance sheet exposure of banks at the end of March was more than three times the size of their consolidated balance sheet.
For FY 2007, it was double the size of their consolidated balance sheet, the report said.
Off-balance sheet exposure, including derivatives, letters of credit and guarantees, are called so because they are not directly funded by banks and do not appear on their balance sheets.
However, these remain as liabilities on the books of banks, and they need to honour the commitment if the client companies fail to do so.
The off-balance sheet exposure of foreign banks, at 2,830.5% of their total assets, has been the highest. For new private sector banks it’s at 301.79%, public sector banks 61.45% and old private sector banks 57.12%.
“We have seen an increase in the off-balance sheet exposure of banks as business in the forward exchange market increased,” said a senior executive with a private sector bank who did not want to be named. “With the rising fluctuations in the currency markets, many banks have entered into simple and exotic forward contracts to hedge themselves against any currency fluctuations.”
Foreign banks, he said, also had high exposure to guarantees and derivatives as their clients have exposure to various currencies and they need to hedge their positions.
Foreign banks’ exposure to these off-balance sheet items is at Rs102 trillion as on 30 March, more than double the Rs50.6 trillion in the previous year. Foreign exchange contracts entered into by them has increased by 103.13% to Rs85.8 trillion at the end of March.
“Banks do not have to bring in additional capital to scale up their derivatives business; their ability to lend, for instance, is usually curtailed by the amount of capital they have on their books. This explains how foreign banks have been able to aggressively ramp up their derivatives business,” said a corporate banking head of a foreign bank who also did not want to be quoted as he is not the official spokesperson.
Banks should also do a careful review of their lending rates based on change in the inflation outlook, domestic liquidity conditions and cost of funds, the central bank said.
“Bank prime lending rates exhibit upward flexibility during monetary tightening, but downward rigidity during monetary easing, which impedes the monetary transmission mechanism,” the RBI report said.
The central bank has slashed key interest rates sharply since October and eased banks’ cash reserve requirements to shield the economy from the fallout of the global crisis.
“As such, these rigidities do not allow the benefits of easy liquidity conditions to be passed on to the borrowers,” the report said.
Saikat Chatterjee of Reuters contributed to this story.
Graphics by Paras Jain / Mint