Mumbai: Indian banks’ bad debts rose for the first time in six years in 2007-08 and the global crisis can worsen credit risks, making it necessary for lenders to have more capital, Reserve Bank of India (RBI) said.
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 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 said in its annual report on trends and progress of banking for the year ending June 2008.
RBI 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,” it said.
The bank said the reduction in bad loans over the past few years had been due to joint efforts by policymakers and banks. Lenders should ensure the gains were not frittered away and it was critical for the banking system to keep additional bad loans to a minimum.
While banks’ gross non-performing assets fell to 2.3% of gross advances in 2007-08 from 2.5% in 2006-07, in absolute terms the figure increased by 12% in the same period, reversing a falling trend since 2001-02, partly due to higher interest rates, it said.
“The turbulence in the global financial markets and its likely macroeconomic impact on the Indian economy, albeit marginal, are likely to have an adverse impact on the credit risk environment,” it said.
Banks’ capital positions were strong and they appeared to be in a better position to withstand shocks on their balance sheets arising from the uncertain economic environment, it said.
Overall capital adequacy requirements of the 77 banks operating in India stood at 13%, much above central bank stipulated norms of 9%, and banks’ capital-to-assets ratio indicated a lower degree of leverage and higher stability.
Competition in the banking sector has increased but the scenario could change as the government may have to allow state-run banks to raise capital from the market, it said.
Government holding in state-run banks, which account for 70% of the banking business in the country, has to be a minimum of 51% according to law.
A roadmap for freeing up foreign banks’ entry into India is also up for review in 2009, it said.
“These developments, as and when they occur, would need to be monitored and guided carefully so that competitive pressures in the banking system are maintained in the interests of overall banking efficiency,” RBI said.