The table provides a snapshot of gross and net non-performing assets (NPAs) as a percentage of advances over the last 13 years. While there was a vast improvement in the ratios during the boom years between 2003 and 2007 in spite of tightening of norms, the fact is that the ratios improved even during the downturn of 2000-03 and have held more or less steady between 2008 and 2011.

Naveen Kumar Saini/Mint

As on 31 March, these restructured advances amounted to 1.06 trillion, more than the gross NPAs, which were 94,088 crore. If the growth in restructured assets is also taken into account, then total growth in impaired advances (gross NPAs + restructured advances) amounted to a huge 39.7% in 2009-10, although this rate of growth dipped to 11.9% in 2010-11.

Studies have shown that NPA growth lags bank credit growth by two years as it takes time for the excesses during a credit boom to turn into bad loans. According to the Reserve Bank of India (RBI), if 25% of restructured advances turn into NPAs, the gross NPA ratio would be 3% and if 100% turn into NPAs, then the ratio would be 5%.

With economists steadily revising downwards their estimates of gross domestic product growth for fiscal 2013, an increase in bad debts is a big risk for the banking sector. The BSE Bankex has underperformed the Sensex this month.

Bank results for the September quarter have shown a sharp rise in NPAs for most public sector banks. However, much of the increase is on account of a shift to a system-based NPA recognition. Private sector banks did rather well on the NPA front, thanks to their retail assets.

The impact of the high level of bad loans is felt on banks’ profits via higher loan loss provisions. How high could these go? According to Nomura Research, “In the current credit cost cycle, we expect loan loss provisions for the Indian banking sector to increase from 72 bps (basis points) in FY11 to 119 bps in FY12F and 123 bps in FY13F—due to credit quality deterioration in sectors like power, aviation, SME (small and medium enterprises), etc. This compares with the past peaks of 156 bps in FY97 and 119 bps in FY04." One basis point is one-hundredth of a percentage point.

Unlike the period following the Lehman bust, when government and monetary stimulus led to a sharp recovery, this time the environment is very different. Only when the interest rate cycle turns will the outlook for bank stocks improve.

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