The asset quality of the Indian banking system has improved significantly over the last 15 years, with GNPA levels coming down to 2.3% in March 2008, from a high of 19.5% in 1995. The improved asset quality had a distinct bearing on the healthy economic scenario, during which period the Indian banking system witnessed a significant growth in its asset portfolio spread over diverse sectors. It is worthwhile to note that the asset mix of the Indian banking system has improved qualitatively during the last decade with greater portfolio diversity in terms of increased exposure to the services sector, which has done remarkably well. The credit risk profiles of corporates also showed distinct improvement. This healthy trend was supplemented in no small way by the improvement in the banks? capitalisation, which improved the cushion to absorb NPAs.
Most banks have put in place robust credit monitoring and risk management systems. Banks today are in a better position to identify sickness in units and come up with early remedial steps. This pro-active credit monitoring mechanism has been largely responsible for banks checking the growth of NPAs. Regulatory authorities like the government and RBI have also come up with timely restructuring guidelines to bail out units temporarily affected by economic slowdown. Most banks have addressed the issue of economic downturn most pragmatically, coming up with restructuring packages in time. The top 6 public sector banks restructured assets aggregating Rs 25,067 cr in 2008-09. This systemic credit monitoring strength has enabled the banks to not only understand the problems of industrial units but also enabled them to come up with viable solutions.
Indian banks had only negligible direct exposure to the type of toxic assets that have contaminated the Western countries? banking system. Although bank credit growth was quite high at around 30 per cent per annum during 2004-07, it would appear that there was no significant relaxation of lending standards. Banks? loans to individuals for housing have been backed by prudent loan-to-value ratios. However, in view of the rapid credit growth to certain sectors, RBI had pre-emptively tightened prudential norms for these sectors in order to safeguard financial stability; provisioning norms for standard assets were also raised across the board except for agriculture and SMEs. These tightened provisioning norms and risk weights have now been rolled back in the wake of slowdown in order to ensure flow of credit to the productive sectors of the economy. This ?dynamic provisioning? approach has facilitated adequate buffers within the banking system. Such ?dynamic provisioning? is now being advocated as general practice internationally.
A more rigorous assessment of the health of commercial banks, recently undertaken by the Committee on Financial Sector Assessment (CFSA) also shows that the commercial banks are robust and resilient. The single-factor stress tests undertaken by the CFSA reveal that the banking system can withstand significant shocks arising from large potential changes in credit quality, interest rate and liquidity conditions. These stress tests for credit, market and liquidity risk show that Indian banks are generally resilient. Given the ongoing financial crisis and its likely impact on the Indian economy, the CFSA conducted stress tests for the end of September 2008. Under the worst-case scenario (150 per cent increase in gross NPAs), the overall capital adequacy position of the banking sector would have declined to 10.6 percent in September 2008?still well-above the regulatory requirement of 9 per cent. Thus, even under the worst case scenario, CRAR remains comfortably above the regulatory minimum.
With the economy slowing down, all industries and particularly the micro, small and medium enterprises encounter problems of low demand for their products, building of excess inventory, reduction in period of market credit on purchases, and delay in realisation of bills and receivables. It is therefore essential that bankers come to the rescue of genuine borrowers in time of crisis, to protect the interest of both?the bank and industrial borrower? for sustaining industrial production, without waiting for borrower to approach the bank.
Although analysts have predicted an upswing in NPAs due to the current economic scenario, the expected deterioration in the asset quality will be within manageable limits. This is driven by the qualitative improvement in the asset quality of banks during the last decade, diverse composition of the advances portfolio of banks and the strength of the balance sheets of corporates.
?The author is CMD, Union Bank, winner of FE India?s Best Bank Award for credit quality