6 reasons why RBI should take note of UBS report on Indian banks

UBS examines 100 potentially stressed companies covering around $100 bn in loans to understand the exposure and lending practices of banks

In a well researched work, broking outfit UBS has come out with a damning report on banking practices in the country.What makes this report different are the tough questions raised regarding the questionable practises of private sector banks, considered sacrosanct by the market.

Yes Bank is at the receiving end of the report. The bank's management has however rubbished the report, saying that UBS is using highly exaggerated numbers and the exposure to stressed assets might be half of those mentioned by the research house. The management went on to add that some assets mentioned by UBS are not stressed and that no new risks have been added to the books.

Nonetheless, the UBS report brings out some interesting facts which were not publicly known. UBS conducted a proprietary survey of over 7,000 collateral documents (used to secure loans) filed at the Registrar of Companies (ROC) pertaining to a sample of around 100 potentially stressed companies (covering approximately US$100bn in loans) to understand the exposure and lending practices of banks.

The idea behind the survey was to attempt to determine which banks are most exposed to potentially stressed corporates; a list of those banks that have continued to lend despite deteriorating financials and finally the quality of collateral and seniority of loans. The findings are quite an eye opener, to say the least. 

Here are 6 reasons as cited by UBS why Reserve Bank of India should take a note of the findings of the report and the process adopted by banks in lending.

1) Extreme leverage:

UBS has surveyed exposure of 100 companies constituting around 15% of corporate loan book and found that nearly 60 per cent of the companies have a debt to equity ratio of greater than five. Around 10 per cent of these companies have a debt to equity ratio of less than 2, the level which is considered prudent. Furthermore, around 50 per cent of these companies have cash interest coverage of less than one, implying that they are not even generating enough to service the debt.

2) Loan approval list exposes the banks:

Yes Bank has the highest credit exposure to these companies at 8.9 per cent followed by PNB at 8.2 per cent and ICICI at 5.5 per cent. For Yes Bank, these exposures accounts for 19 per cent of loans while they are 14 per cent for ICICI and 10 per cent for PNB. Yes Bank has contested these numbers.

3) Continued funding:

The report points out that many banks continued to fund these companies despite the stress. Yes Bank increased its loan by a whopping 309 per cent followed by 103 per cent by ICICI Bank and 97 per cent by HDFC Bank. Loan approvals as a percentage of the networth were 125 per cent for Yes Bank; 100 per cent for PNB and 67 per cent for ICICI Bank. Yes Bank says that they have not added new risks to the book.

4) Not enough collateral:

What can make the loans toxic is the poor level of collateral against them. Only 37.9 per cent of loans are covered by immovable property while 25.3 per cent are covered by movable and immovable assets and only in 51.6 per cent of the case does the bank have a first charge over the asset.

5) Public sector banks are better covered:

The report says that immovable assets backed loans are the highest for public sector banks with BOB accounting for 43 per cent, followed by PNB at 36 per cent and SBI at 35 per cent. Among the private sector players, Axis at 35 per cent and ICICI Bank at 31 per cent are relatively better covered.

6) High share of subservient charge:

Quality of loan becomes weak if banks have a subservient or subordinate charge on the asset. Yes Bank, the report points out has the highest level of subservient charge at 21 per cent followed by IndusInd Bank at 17 per cent and ICICI Bank at 11 per cent.

The report has shown that all is not well with the private sector banks. Market has been under the impression that quality of assets of only public sector banks are bad, but this report breaks that myth. It also highlights the asset quality and more importantly the process adopted by banks behind loan approvals which the central bank needs to take notice of. In case the credit cycle is prolonged, some of the private sector banks covered in the report will be adversely hit.