Much of this -- up to 35 per cent of the total banking assets -- would be accounted as NPA were it not for the process of "ever greening", a euphemism for rescheduling and restructuring of loans to make them good assets in the book, the rating agency said.

According to S&P financial institutions ratings director Ken McLay, the Reserve Bank gross NPA estimate of 17.8 per cent of the banking industry is suspect on account of the liberal country definition of NPA and widely-prevalent practice of "ever greening". Domestic banks recognise NPAs only after 180 days of default, while the international norm is 45 days to 90 days.

"Where a meltdown like the one that occurred in east Asia occurs in India, then most of the assets shown as good will turn bad," he said.

S&P has placed the country's banking system at the bottom in a ranking on the risk-profile of various Asian nations. The country's banking system is rated high risk and features alongside Indonesia and is placed lower than crisis-riddled Korean and Thai banking systems.

The rationale for the low rating, according to McLay, is that even if the insular structure of domestic currency market may prevent a similar meltdown, it is imperative for the country to open up its currency market while moving towards full convertibility. "When markets are opened the risks for the banking sector will increase. The banks will no more be in a position to "manage" their NPAs," he said.

Standard & Poor has also assigned below investment grade rating of BB+/B with negative outlook to the long-term foreign currency debt of ICICI, IDBI and Bank of Baroda. These ratings are mostly constrained by the sovereign rating assigned to the country which is on par. According to McLay, the key considerations that is factored into the rating of Indian financial institutions and banks are the weak asset quality, high-level of industry risk and underdeveloped risk-management capability.

McLay also raised concern about the large amount of bad loans arising from directed lending, which amounts to about 45 per cent of the gross NPA. He questioned the possibility of achieving 5 per cent NPA level as targeted by the Narasimham committee because of the continued existence of directed or priority-sector lending.

INSIGHT

Banks need to be more pro-active

The S&P team recommendations have been detailed previously in the Narasimham Committee report on banking-sector reforms. The report has recommended that the NPA classification norms be tightened from 180 days to 90 days over a period of five years. This will give banks some time to restructure but will also force most banks to face up to the inevitable.