The Reserve Bank of India, or RBI, has raised the spectre of loans restructured during the 2008 credit crisis becoming a drag on banks amid noise for the next round of bailout for airlines and power companies.
Bad loans for banks as a percentage of total assets would more than double if all the loans that were given special dispensation during the crisis slide back to the non-performing category.
"There was always a concern with regard to the restructured standard accounts," the RBI said in its report on Trend and Progress of Banking in India. "The concern is that the recoveries have not kept pace with slippages. Rising interest rates and substantial amount of restructuring done during the crisis, if not done with due care, are likely to put further pressure on asset quality of banks."
If all the loans restructured during the crisis were to turn bad, total nonperforming assets in the system would balloon to 5.01%, from 2.35%, the RBI estimate shows. If 15% of the loans turn bad, NPAs would rise to 2.74%, and if 25% turn bad, NPAs would increase to 3.01%.
There are doubts about the strength of the Indian banking system with thousands of crores of loans for utilities, state-owned power distributors and aviation companies poised to turn bad.
Whenever a sector faces tough times, as did real estate in 2008, and now power, there is a call for special dispensation. While it helps to hide the bad loan ratio in the short term, these toxic assets remain in the system, pulling down banks' performance for years. Ratings agency Moody's downgraded the Indian banking sector on November 9 to 'negative' from 'stable'.
Moody's cited "concerns that an increasingly challenging operating environment will adversely affect asset quality, capitalisation, and profitability". Banks' lending to the infrastructure sector, such as roads, ports and utilities, could be the next big stress area for them.
"A specific area of concern ... is the concentrated and high pace of lending to the infrastructure sector by public sector banks, raising apprehensions of increasing delinquencies in the future," said the report.
Crisil, the Indian unit of ratings company Standard & Poor's, estimates that power sector loans amounting to Rs 56,000 crore could be at risk. Punjab National Bank and others have begun to change the tenor and interest rates for power sector loans.
This stress could also cripple the capital ratios of banks which face stringent norms under the so-called Basel-III, which mandates higher capital and comes into effect in 2013.
"At the aggregate level Indian banks will not have any problem in adjusting to the new capital rules," said the report. "A few individual banks may fall short of the Basel-III norms." It reiterated the widespread belief that Indian banks charge their customers disproportionately more than what their counterparts do even after factoring in various obligations imposed on them.
"The net interest margin (the difference between lending and borrowing rates as a percentage of assets) of the Indian banking system is higher than in some of the other emerging market economies even after accounting for mandated social sector obligations such as priority sector lending and the government's anti-poverty initiatives."
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