Bankers’ bane: rising bad debts to weigh heavy in the new year

Bankers’ bane: rising bad debts to weigh heavy in the new year

Mumbai: India’s banks may have escaped the worst of the global financial turmoil this year, but face a difficult 2009 as slowing economic growth causes defaults to rise and bad loans to pile up, bankers and analysts say.

Gross bad debt, or non-performing assets (NPAs), as a percentage of total bank advances may more than double to as high as 4.7% in 2009-10, from the current 2.3%, Mumbai-based Antique Stock Broking Ltd said in a December report. It expects the bad loan ratio to peak at 5% in 2010-11.

“Banks that already had good quality norms in place will see their asset quality protected," Ravi Sankar, an analyst at Antique Stock Broking, said. “But banks that did not pay attention to asset quality during the boom period will face problems in 2009 because NPAs for them will be the highest."

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Economic growth, which averaged 8.9% in the past four years, is set to slow in the fallout of the global downturn and credit crunch that has hurt corporate investment and consumer demand. The economy grew 7.6% in the September quarter, down from 9.3% a year ago, while manufacturing output shrank 0.4% in October, the first contraction in at least 13 years.

The impact on bank asset quality has started to show. For the quarter ended 30 September, combined gross bad debt at the top 10 banks by market capitalization rose 7% from the preceding quarter to Rs35,290 crore as customers started defaulting on loans because of increased borrowing costs, according to a Mint analysis.

Year-on-year gross NPAs at these banks, including State Bank of India and ICICI Bank Ltd, the country’s two largest lenders by assets, shot up 14.5%.

Loans on which no principal or interest has been paid for at least 90 days are classified as NPAs under Indian banking rules. Gross NPAs include loans against which banks have set aside money to cover the risk of default. Net NPAs, which exclude such loans, at the 10 banks rose by around 3.5% to Rs14,943 crore in the quarter ended September. On a year-on-year basis, net NPAs jumped 6.5% from Rs14,023 crore a year earlier.

The key challenge for banks would be to minimize defaults and improve asset quality.

“The approach of bankers towards incremental credit would be tempered with caution as they focus on operational cost efficiencies, risk management and profitability through rebalancing of their asset and funding mix," said Chanda Kochhar, chief executive officer-designate of ICICI Bank. “This would mean managing their portfolio of exposures through the transition phase, as also competing for low-cost deposits."

Analysts expect the proportion of low-cost current and savings accounts (CASA) on the total deposit base to tumble from the present level of 32-40%, as customers have started locking their money in long-term fixed deposits that offer 10.5% returns.

Banks pay negligible interest on CASA, compared with the 8.5-9% they pay on term deposits with a minimum one-year lock-in period.

Banks started cutting deposit rates in December as they had to lower their lending rates.

After raising interest rates to counter inflation in the first half of 2008, the Reserve Bank of India (RBI) started cutting rates to infuse liquidity into the system as the global credit crunch began to hurt Indian companies. As a result, banks have had to cut deposit rates as well.

Since October, RBI has cut its repo rate, or the rate at which it infuses liquidity in the banking system, by 250 basis points to 6.5%.

The central bank also cut its reverse repo rate, or the rate at which it sucks out liquidity, by 100 basis points to 5%, and the cash reserve ratio, or the proportion of banks’ deposits to be maintained with RBI, by 350 basis points to 5.5%. One basis point is a hundredth of a percentage point.

The cut in key policy rates came after five years, but will provide no succour to banks as factors such as slower manufacturing and job cuts kick in.

On other critical parameters too, such as the ratio of capital to risk-weighted assets and earnings, analysts expect Indian banks to feel some pain.

Their prognosis: Profit growth in 2009 will be lower year-on-year for most lenders, though they will not likely face solvency issues as all banks are well capitalized under RBI guidelines.

Most banks raised capital in late 2007 taking advantage of a booming stock market, which should help them meet the higher capital requirement under Basel II norms, a global accounting standard that will become mandatory in India from April.

But the impact of a rise in NPAs is likely to weigh heavily on other areas, analysts said. Net interest margins, the difference between what banks charge for loans and pay for funds, for instance, are likely to shrink.

Most banks reported high margins of 3 to 5 percentage points in 2007-08 when they aggressively expanded their credit portfolio. Maintaining these levels will be tougher in 2009 as provisioning for bad debt increases, yields on advances and investments decline, and the cost of funds continues to be expensive.

Even treasury gains expected in 2009 are unlikely to be spared. As interest rates decline further to encourage growth, yields on 10-year government bonds are expected to fall below 5% in March, down from a peak of 9.5% in July and 5.5% currently, resulting in treasury gains for banks.

The price of bonds is inversely proportional to yields. Most of these treasury gains, however, are likely to be offset by higher provisioning for bad debt.

According to ICICI Bank’s Kochhar, the current downturn is distinctly different from the slowdown of the mid-1990s, when corporate customers had higher leverage ratios.

“While ‘lazy banking’ was a syndrome of the previous era, the current regime calls for active risk management, even while you compete aggressively with other players on both the liability and asset side of the balance sheet. The current focus is on building up a sustainable and profitable business model," said Kochhar.

In the current climate, companies have debt-equity ratios of below 1 and continue to report healthy cash flows, which would help them implement committed projects as well as service existing debt obligations, she added.

“Nobody knows what is there in the long term, but in the short term, we (banks) will make sure that we conserve capital, assess risks very carefully before we lend, and monitor our credit portfolio and asset quality on a daily basis," said R.S. Reddy, chairman and managing director of Andhra Bank.

“We will see that we are not over-leveraged and we don’t take riskier assets that we don’t understand ourselves."

The subprime crisis that emerged in 2007 in the US and the resulting credit crunch crossed the oceans to Europe and developing economies. It forced Lehman Brothers Holdings Inc. into bankruptcy and the sale of Bear Stearns Cos., Merrill Lynch, Wachovia Inc. and Washington Mutual Inc. Mortgage lenders Fannie Mae and Freddie Mac, as well as American International Group Inc. (AIG), the largest US insurer, had to be bailed out by the government.

The tremors were felt in India too, as corporate clients took banks to court for failed bets on derivative hedging done during the boom of the past three years.

Most of these disputes are already being settled out of court and analysts see the trend gather speed in 2009.

“Banks cannot be defeated in court because they had their compliances and checks and balances in place before they sold the products," said Vipul Shah, a banking analyst with K.R. Choksey Securities Ltd. “But banks will be better off settling the claims out of the court because at the end of the day, these are their customers, and banking is a low-margin volume game where they cannot afford to lose customers."

Anita Bhoir contributed to this story.