Mumbai: Reserve Bank of India (RBI) governor Raghuram Rajan on Thursday said that while the impact of the regulator’s asset quality review will hit the profitability of some banks in the short run, the clean-up will help support economic growth in the future. Rajan also warned analysts against “wild claims" on the size of the asset quality problem, adding that RBI expects the problem and the additional capital requirements of banks to be manageable.

“...while the profitability of some banks may be impaired in the short run, the system, once cleaned, will be able to support economic growth in a sustainable and profitable way," said Rajan, while speaking at a banking summit organized by the Confederation of Indian Industry in Mumbai.

He said the review was undertaken to ensure that banks were taking proactive steps to clean up their balance sheets. As part of the process, the regulator had identified loans that were of concern, as well those that had potential weaknesses.

Speaking at the same conference, RBI deputy governor S.S. Mundra said that stressed assets across public sector banks, which include gross NPAs and restructured loans, together with loans written off by banks, stood at 17% of the banking sector’s total outstanding loans as of September 2015. For the banking industry as a whole, this number stands at 14%.

“For the loans that are of concern, the banks are attempting to regularize the loans that can be put back on track, and are classifying those that cannot for deeper surgery—and taking provisions in accordance with the degree of extant stress in the loan. They will also make provisions for loans that have weaknesses. Our intent is to have clean and fully provisioned bank balance sheets by March 2017," said Rajan.

The profits of a number of banks, particularly public sector banks, have taken a hit because of the RBI’s asset quality review and this has sent bank stocks tumbling. For 30 of the 39 listed banks that have reported earnings so far, gross NPAs have risen 26% quarter-on-quarter and are up 40% compared to a year ago. Provisions have surged 74% quarter-on-quarter and 80% on a year-on-year basis. This has pulled down the consolidated net profit of these banks by 42% between the September and December quarters. Year-on-year, the net profit for this set of banks is down about 46%.

However, Rajan warned against exaggerating the scale of the problem. “There are some wild claims being made by some financial analysts about the size of the stressed asset problem. This verges on scare-mongering," said Rajan.

RBI expects only a small minority of banks to see capital fall below the minimum required levels, which will require the government to infuse equity. However, other banks may need a “top-up" of their capital, said Rajan, adding that the government is committed to standing behind the banks.

“RBI will provide whatever liquidity is needed by any bank that needs it, though we do not foresee liquidity stress," he said.

Rajan added that banks can now carve out an additional 3 percentage points over and above the current 7% of bonds held under the statutory liquidity ratio (SLR) for maintaining liquidity coverage ratio (LCR).

In a separate release, RBI notified this flexibility in LCR calculation for banks. Under Basel-III norms, banks are expected to hold 70% high-quality liquidity assets under LCR from January 2017, which would be increased to 100% by January 2019.

Banks are mandated to invest a minimum 21.5% of their deposits into government bonds under SLR.

RBI is also working on identifying currently non-recognizable capital that is already on bank balance sheets, such as undervalued assets, which banks may be allowed to count as capital, said Rajan.

Banks are already listing such non-recognizable capital items that can be included. For instance, the country’s largest lender, the State Bank of India, has chalked out a road map through which it is planning to boost capital from non-core assets such as holdings in non-bank subsidiaries and real estate. SBI has a real estate book worth 20,000 crore and this is valued really low, chairman Aru-ndhati Bhattacharya said after the release of the bank’s results.

Addressing the issue on the timing of the clean-up, which comes against the backdrop of stress across global markets and in the domestic markets, Rajan said that the process was started in April 2015 when markets were calmer. However, he maintained that cleaning banks’ balance sheets now rather than later makes imminent sense.

“The most plausible explanation I have is that the stressed balance sheet of public sector banks is occupying management attention and holding them back, and the only way for them to supply the economy’s need for credit, which is essential for higher economic growth, is to clean up," he said.

Rajan also argued that waiting for growth to pick up in the hope that stronger growth will help revive some of the projects that have turned bad is not the right approach. “...to the question of what comes first, clean up or growth, I think the answer is unambiguously—clean up! Indeed, this is the lesson from every other country that has faced financial stress," he said.

Mundra, in his remarks, said that banks and borrowers are on board to resolve the prevailing problem of weak asset quality.

“I am very happy to see that all the concerned are showing willingness. In the true spirit of the discussions which were held and the diagnostics which were made, they are moving in that direction," said Mundra.

His presentation on the recently concluded asset quality review showed that RBI had found many instances of round-tripping of funds by companies, repayment of short-term loans through overdraft facilities and incomplete evaluation of viability of projects. He declined to elaborate on these malpractices.

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