Silver lining to AQR exercise: Bank valuation to get boost

The asset quality review (AQR) hit hard the bottomline of banks in 2015-16. There is a silver lining, though, with a higher valuation for the lenders’ shares, says Financial Stability Report (FSR).

AQR has resulted in unprecedented pressure on the profitability of some banks in the short term. But the push towards cleaning up of their balance sheets is expected to improve their market valuations through a greater trust in accounting numbers, according to FSR, prepared bi-annually by the Reserve Bank of India (RBI) for the Financial Stability and Development Council. There will now, says the report, be more trust in the banks’ account numbers. And, augment their capacity to lend more and support economic growth in the medium to long term.

The AQR covered 36 banks, including all government-owned ones, accounting for 93 per cent of gross advances. Banks and the regulator worked on this during the third and fourth quarters of 2015-16. What was reviewed constituted a little more than 80 per cent of the total credit dues.

The idea behind it was that the level of non-performing assets does not in itself give full information about the quality of a credit portfolio. The AQR intended to make banks reassess this credit risk of their asset portfolios, the report said.

The exercise sought to validate objective compliance with applicable income recognition, asset classification and provisioning norms and exceptions were reported by the supervisors as divergences in asset classification and provisioning.

Risks to banking industry have sharply increased since September 2015 as surging bad loans dragged lenders’ profitability. Banks’ return on assets fell to 0.4 per cent at the end of March from 0.8 per cent a year ago, according to the FSR.

The industry’s gross bad-loan ratio jumped to a 13-year high of 7.6 per cent, following a six-month RBI audit of banks’ bad-debt disclosures. Under a “baseline stress scenario,” that ratio may rise to 8.5 per cent by March 2017.