There is an increase in NPAs for the banking system as a whole. With the provisioning to gross NPA ratio for most banks also showing a relative decline, there is a clear cause for worry in terms of adequate provisioning
There are two aspects to the deterioration in asset quality. First, there is the bank sovereign investment in government assets/securities for meeting SLR requirements. As per the latest estimates, banks are holding R3.5 lakh crore in government securities in excess of SLR requirements (29.9% vis-?-vis 24%). Even though these investments are safe, as expected, such huge investments in gilts are a direct corollary of the size of the net government borrowings, budgeted at R4.79 lakh crore for this fiscal. Additionally, such a high level of government borrowings creates, among other things, unprecedented liquidity pressures within the system. For example, the current redemption profile of government bonds reveals a huge concentration in the FY13-23 bucket (in contrast, the supplies are very light between FY24?26). This may have direct implications for managing liquidity by RBI.
The second aspect is, however, directly relevant here. This is the increase in NPAs for the banking system as a whole in the last fiscal. Interestingly, as we had pointed out, the FSR report had raised this issue in December 2011, when it pointed out that there was an increasing trend of assets getting restructured and impaired assets in credit to the infrastructure sector. We believe there are reasons to be worried.
Table 1 summarises the trends in net NPAs/net advances for selected banks (9 public sector banks in 2012, and SBI separately). Interestingly, the last column shows whether the said ratio in March 2012 is higher than in March 2009, the year of the Lehman crisis. As per the trends, all but one of the banks for the fiscal ended March 2012 had higher NPA/net advances as compared to March 2009. For some banks, the increase was significant, while for some banks the ratio has increased progressively since FY09. The results of SBI are a positive surprise (there was a slippage but lower than market expectations, and net profit jumped by 42%). The only point of solace is, however, as per RBI, ?A cross country comparison of NPA ratios reveals that, notwithstanding the recent deterioration, Indian banks fared better than banks in other countries.?
The increase in net NPAs/net advances, has impacted the return on assets (ROA). Comparing the March 2012 figures with March 2009, we find that 12 of the 19 public sector banks witnessed a dip in ROA in the last fiscal. What is more worrisome here is that the movements in ROA between 2012 and 2009 were asymmetric, implying that the fall was more precipitous compared to the increases that were relatively small.
Even though the net NPA/net advances for most banks in India remain below 2%, we believe that the incremental NPA/incremental advances may be a more dynamic concept (indicating the slippages in advances during the fiscal). This ratio has significantly deteriorated in FY12 (vis-?-vis FY09). Disturbingly, the ratios in 2012 show significant scatter dispersion at the higher end, indicating that there may be evidence of concentration risk in the banking system. Equally important is the provisioning to gross NPA ratio for most banks showing a relative decline in FY12, a clear cause for worry in terms of adequate provisioning.
So, what are the implications of higher NPAs going forward? First, Indian banks are currently in the process of implementing Basel requirements. A higher-than-expected loss given default (LGD) estimate is likely to significantly impact the loss estimations, and, to that extent, Indian banks may have to rethink on pricing/interest rates and subsequently capital calculations (a higher LGD will imply higher expected losses, and hence higher provisions). If this is the case, interest rates offered by the banks are unlikely to see any significant downward revisions from the current levels, even if the situation so warrants.
Second, the reasons for NPAs are primarily classified into two components. The first is the overhang component, which is due to environment reasons, business cycles, etc (a suitable proxy for this may be net NPAs/net advances). The second is the incremental component, which is due to internal bank management, credit policy and terms of credit, etc (a suitable proxy is the slippages to total advances). We believe a jump in the incremental component may be a leading indicator of a worsening of risk mitigation techniques within the banking system, and must be watched very closely.
Over the next couple of years, the Indian banking system, as per independent estimates, may require a capital infusion of close to R3 lakh crore for adhering to revised Basel III capital adequacy norms. RBI has already laid out the roadmap for Basel II & III adoption, and has also been planning to make changes in the regulatory norms, in so far as introducing counter-cyclical measures to mitigate the downturn risks (for example, the proposed dynamic provisioning norms). Going by the sheer size of the capital infusion estimates, we think that the banking system will continue to throw up newer challenges over the next few years. The entry of newer private sector banks (once allowed) may also introduce an element of welcome competition. Given all this, it is imperative that we maintain a judicious balance between risk and return for the Indian financial system.
The author is director, Economics & Research, FICCI. Views are personal. The author thanks Aarjabh Das for research