Higher rate to hit banks' asset quality: Crisil

Weakening debt servicing ability of the corporate sector, particularly the small and medium enterprises, due to higher interest rate, might result in higher non-performing assets (NPAs) in the current financial year.

According a report by rating agency Crisil, banks’ gross non-performing assets, which was 2.3 per cent as on March 31, is expected to increase to nearly three per cent by March 31 next year.

Crisil expects overall slippages to NPAs for banks to increase to around 2.5 per cent in 2011-12, from an average of 2.1 per cent, over the past three years.

The sectors with a weak demand-supply scenario, intense competition, and high leverage will be the most impacted. Also, sustainability of demand across industries, such as cement, automotive, construction, and textiles, will be a key monitorable for the credit quality of India’s corporate entities,” the report said.

The rating agency also says the return on assets (RoA) for the banks might come down below one per cent in the current financial year, the lowest in five years, as the average net interest margins of the lenders is expected to slip below three per cent, since the ability of banks to pass on further hike in policy rates is “limited”.

Over the last 18 months, the Reserve Bank of India has raised the the key policy rate or the repo rate 12 times (by 450 basis points) to 8.25 per cent. So far, banks have largely passed on the increase by raising the lending rates, but this has has resulted in a pressure on the asset quality.

“So far, the banks have been passing on increases in funding cost to their borrowers; this has enabled them to maintain their net interest margin at around three per cent. Consequently, the banks reported a healthy RoA of about 1.1 per cent in 2010-11, despite higher provisions for pension liabilities. The banks will have limited room to pass on any further increases in funding costs to borrowers. This will result in their NIM reducing to less than three per cent, and RoA dipping to around 0.95 per cent in 2011-12,” the report said.