Aggressive expansion causes bad debts to pile up on public banks

Aggressive expansion causes bad debts to pile up on public banks

Some of India’s public sectors banks may be bracing for an uncomfortable ride with fresh bad debts acquired during 2006-07.

Results for the April-June quarter of banks such as Punjab National Bank, Dena Bank, UCO Bank, United Bank of India and Vijaya Bank show that fresh bad debts accumulated on their books in 2006-07.

These bad debts, or non-performing assets (NPAs), are as high as 3% of advances (or loans) made made last year in the case of some banks compared with the industry average of 1.77%.

An August report released by domestic credit rating agency Icra Ltd said some stress will emerge in the retail as well as corporate loan portfolios of the banks. That’s because of the aggressive expansion plans of firms and higher interest rates that have increased the monthly interest payouts of borrowers and, in turn, resulted?in?more?people?and?firms?being unable to repay the loans.

Icra cautions that banks which have seen a rate of fresh bad loan generation of 3% in the past fiscal year can see their bad loans nearly double to 5.42% in March 2010. This is assuming that the banks will be able to recover only 20% of their bad loans, while lending (or credit) grows at 25% for the banking industry.

Icra said banks would need to provide for the likely increase in bad loans “at a pace higher" than the last three years to maintain their bad loan percentages at relatively low levels. The report said that higher provisioning for these bad loans would dilute the banks’ earnings by 0.5-0.6% over the next two or three years compared with 0.3% in 2006-07. Icra suggests that public sector banks could bring down this impact “by improving core profitability or bringing down losses in their fixed income portfolios."

Vijaya Bank chairman and managing director Prakash P. Mallya said there’s no cause for alarm: “2006-07 saw fresh NPA accretion on account on higher rate of interest that translated into larger monthly payments on mortgages and personal loans. But this is a temporary phase. We have strengthened our risk management system and will be able to contain our NPAs well."

Currently, about half of the retail portfolios of the public sector banks come from mortgage loans made at floating rates of interest. However, the recent hardening interest rate scenario has left banks with no choice but to increase the equated monthly instalments of borrowers.

Interest rates are at a five-year high and an increase in repayment amounts has resulted in banks landing up with more defaulters as the incomes of borrowers have not kept pace with the rise. Besides mortgages, other retail credit categories such as auto and personal loans have also seen an increase in the number of defaulters.

The Indian arm of another international rating agency, Fitch Ratings Ltd, in a July report said the business environment surrounding retail two-wheeler financing in India has weakened and is currently reflected in the increasing number of defaults.

A loan that’s repaid after 180 days is now charged a 6% rate of interest of the original principal outstanding in some cases, compared with a maximum of 3.6% in 2006. “Intense competition in the segment and rural expansion has led to looser criteria for advancing loans. This resulted in deterioration in the credit quality of the? portfolios,"?wrote?Fitch Ratings India associate director Peeyush Pallav in the report.

Public sector bankers say the risk is being overplayed. A general manger in the stressed assets division of a New Delhi-based public sector bank said, on the condition of anonymity, that higher bad loans were from the accumulation of bad agricultural loans over the last five or six years or so, when farmers were unable to repay their debts due to the droughts. With a timely monsoon this year and good crops, he expects the situation to change.