Accretion of doubtful assets to push credit costs

The pace of slippage on doubtful assets for public sector banks (PSBs) moderated in the July-September quarter. However, bad loans of recent vintage have also become sticky and more of provisioning for these would be needed, the longer these stay on the books.

A doubtful asset is one in the sub-standard category for at least 12 months. Banks have to make 100 per cent provision for the extent to which advances are not covered by the realisable value of security. For the secured portion, the provisioning obligation moves up in a graded manner. Banks have to set aside 25 per cent for loans substandard for 12 months.  They have to cough up about 40 per cent when the account remains in the doubtful category for one to three years and 100 per cent for those in the category for more than three years.

 

A senior official with the Indian Banks' Association (IBA) said even with a positive change in sentiment on the economy, if a resolution of bad loans of recent origin fails to happen in a time-bound manner, it will be  a “grave situation”. Interest income has shown tepid growth, reflecting the economy’s slowdown for over three years. This has taken a toll on the capability of state-run banks’ absorbing a higher burden.

 

Global rating agency Moody’s, in its recent report on Indian banking, said the level of credit costs over the past three years had not been in line with the new non-performing loan (NPL) formation rates, which had led to a decrease in loan-loss coverage ratios.

The credit quality of the current stock of corporate NPLs is particularly poor. Hence, their default rates could be higher than historical levels. Given this, it is prudent for banks to increase their loan-loss coverage from current levels. This implies that for the next two to three years, credit costs are likely to remain high, Moody’s added.  It is not that banks would face only gloom. The obligation to set aside more amounts for these “hard assets” might go up but the upturn in economic climate could also ease the provisioning pressure. A softening of interest rates could, among other things, come to their help. With a benign interest rate cycle, banks could book substantial profits on their huge government bond portfolio, part of which could be used for these non-performing assets, noted a head of credit monitoring at a PSB.

Moody's said banks had not been conservative in recognising NPLs in this credit cycle. Rather, they have restructured many impaired loans but kept these in the standard category. The lapse rates (standard restructured loans falling into the NPL category) would be higher than the historical average, at 25-30 per cent. Even as the operating environment improves, lapse rates are likely to remain high, on account of the lagged impact of optimistic NPL recognition over the past three years, it said.