July 2, 2012 / 9:31 AM / 5 years ago

BREAKINGVIEWS - Deteriorating asset quality strains Indian banks

An employee arranges currency notes at a cash counter inside a bank in New Delhi June 8, 2010.Mukesh Gupta/Files

MUMBAI (Reuters Breakingviews) - As India's growth rate fades, its banking system is developing bad habits. Debt restructurings are on the rise. And Indian banks have the lowest bad debt reserves in the Asia-Pacific region. Without an improvement, the pressure to fudge the numbers will only increase.

Graphic: Stressed assets: r.reuters.com/byb78s

The Reserve Bank of India's Financial Stability report, released on June 29, said that banks remain comfortably capitalised, but the central bank is concerned about the deteriorating quality of the banks' loan books. In the year ending March 2012, the ratio of gross non-performing assets (NPAs) rose to 2.9 percent of total loans, up from 2.4 percent a year ago.

Debt restructurings are also on the rise. In the past year, banks sought to restructure a record $12 billion in corporate loans - an increase of 156 percent. Ratings agency Crisil expects the total to double in the coming year. India's Debt Restructuring Mechanism allows banks to ease terms on loans without setting aside provisions. What's more, banks are being flexible with many loans - including $4 billion to Air India and $5.5 billion to loss-making state electricity boards - without either formally classifying them as NPAs or ushering them through the formal mechanism.

Meanwhile, evergreening, where banks lend additional money to keep stressed borrowers from defaulting, is common practice. Property experts Knight Frank estimate that at least a tenth of real estate loans are stressed, more than twice the 3-4 percent cited by banks. The level of NPAs on infrastructure lending, around half a percent of total loans, looks suspiciously low, since these loans have increased from 7 to 15 percent of the banks' overall loan books since 2007.

The low level of reserves at Indian banks may be encouraging them to fudge the numbers. Most banks reported allowances of less than the RBI's minimum of 70 percent of probable losses on total NPAs. At 69 percent, Indian banks' average level of reserves of bad loans is far below China's 252 percent and Indonesia's 212 percent. Setting aside greater provisions will hurt the banks' bottom lines. But without a bigger buffer, the banks' bad habits will only worsen.

CONTEXT NEWS

- The Reserve Bank of India's Financial Stability report, released on June 29, said that India banks remain resilient to credit, market and liquidity risks and would be able to withstand macroeconomic shocks, given their comfortable capital adequacy positions.

- However the report also said that asset quality concerns persist and liquidity pressures have intensified. Credit and deposit growth in the banking sector have decelerated while banks' reliance on wholesale funds has increased.

- Indian banks sought to restructure a record $12 billion in corporate loans through the Corporate Debt Restructuring Cell, an increase of 156 percent on the year before based on data from the year to end-March. The Corporate Debt Restructuring Mechanism is a voluntary, non-statutory system based on Debtor-Creditor Agreement and Inter-Creditor Agreement and the principle of approvals by super-majority of 75 percent creditors. In the case where a loan has not already been classified as non-performing both the creditors and borrowers can refer a loan account to the CDR cell for restructuring.

- RBI report: link.reuters.com/dah29s

Editing by Peter Thal Larsen and David Evans

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