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Photo: Bloomberg
Photo: Bloomberg

IMF sounds a warning note to Indian banks

After Russia, Indian banks have the least capacity among lenders in emerging markets to absorb losses

New Delhi: Indian banks have the least capacity, after Russian ones, among lenders in emerging markets to absorb losses—a fact that could destabilize the country’s banking system, the International Monetary Fund (IMF) warned on Wednesday.

“Loss-absorbing buffers appear particularly low in Chile, Hungary, India, and Russia, and deterioration in loan quality could threaten capital levels. Furthermore, in India, Russia, and Turkey, loss absorbing buffers have deteriorated quite substantially in recent years," the Fund said in its bi-annual Global Financial Stability Report.

According to the report, the loss-absorbing buffer of the Indian banking sector is 7.9% of risk-weighted assets against 7.8% in Russia and 11.3% in China.

“A significant share of debt in Argentina, Brazil, China, India, Nigeria, and Turkey is owed by firms with relatively constrained repayment capacity in terms of interest-coverage ratios, and in Turkey a significant share of this debt is in foreign currencies," the report said.

The Reserve Bank of India (RBI) on 30 March allowed banks to use up to 50% of their counter-cyclical buffer to provide for non-performing assets (NPAs), up from the 33% that they were allowed to use so far.

A counter-cyclical buffer is the mandatory capital that banks are required to keep aside, beyond their minimum capital requirements, to deal with extraordinary situations. Counter-cyclical buffers were introduced globally after the financial crisis of 2008 to ensure that banks are not short of capital whenever systemic risks increase.

RBI said on 30 March that banks could use up to 50% of the counter-cyclical provisioning held by them as at the end of 31 December 2014, for making specific provisions on NPAs. In India, bank provisions above the compulsory 70% provision coverage ratio are considered counter-cyclical.

Indian banks have seen a dramatic jump in bad loans with many infrastructure projects stuck, largely due to issues related to the acquisition of land, the availability of fuel, or delays in securing environmental approvals as well as due to poor credit evaluation procedures in some banks.

With the National Democratic Alliance government managing to push through key coal and mining bills in Parliament and announcing a bailout package for stranded gas-based power projects, bankers are hoping that stalled projects will be revived.

Gross non-performing assets in the Indian banking system stood at 4.5% of total loans at the end of December, with bad loans of state-run banks increasing to 5.1% of all advances at the end of the fiscal third quarter in December, according to estimates by rating agency Icra.

The reported level of bad loans is also set to go up starting fiscal 2016, as a benefit given to restructured loans was withdrawn starting 1 April. Under that benefit provided by RBI,, in the first year after restructuring, banks needed to provide for only 5% of the loan. Now the restructured loans will be categorized as bad loans, attracting a minimum provision of 15%.

The government hopes to improve the health of commercial banks to boost credit growth and prepare the lenders to meet tighter capital requirements. However, with the government deciding to capitalize state-run banks only on the basis of performance, many lenders have been left with little option but to raise capital in the absence of government support.

Though finance minister Arun Jaitley said banks are free to raise capital from the markets, bankers have expressed concern that the lenders may not be able to raise funds from the market when the government—their majority stakeholder—is reluctant to inject more capital.

The government had announced in February that it would infuse only 6,990 crore in nine public sector banks in 2014-15. The budgetary allocation in 2015-16 is only 7,940 crore, which is unlikely to meet the capital requirements of all state-run banks.

The low loss-absorbing capacity of Indian banks is a matter of concern and isn’t being taken seriously enough because it is implicitly assumed that the government will bail out public sector banks, which control 70% of the Indian banking system, should they fall into trouble, said Bobby Parikh, partner at BMR and Associates Llp.

“A complete overhaul of the public sector banks (PSBs) is needed, including their governance, ownership and lending procedures. Private banks do not even remotely have the same problem regarding bad loans as the public sector banks. PSBs should also be allowed more independence in their functioning without political interference," he said.

Last year in April, the International Monetary Fund had said that high debt in some Indian companies could pose a risk to the country’s economic stability. A third of the corporate debt in India has a debt-to-equity ratio of more than three, the highest degree of leverage in the Asia-Pacific region, the Fund said.

A high debt-to-equity ratio indicates that a company has been borrowing to fund expansion instead of raising money from the market. This can harm the health of a firm if interest rates rise and economic growth falters.

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