Breaking the bank

As India’s growth rate fades, its banking system is developing bad habits. Debt restructurings are on the rise. And, Indian banks have the lowest bad debt reserves in the Asia-Pacific region. Without an improvement, the pressure to fudge the numbers will only increase.

The Reserve Bank of India’s Financial Stability report, released on June 29, said that banks remain comfortably capitalised, but the central bank is concerned about the deteriorating quality of the banks’ loan books. In the year ending March 2012, the ratio of gross non-performing assets (NPAs) rose to 2.9 per cent of total loans, up from 2.4 per cent a year ago.

Debt restructurings are also on the rise. In the past year, banks sought to restructure a record $12 billion in corporate loans - an increase of 156 per cent. Ratings agency CRISIL expects the total to double in the coming year. India’s Debt Restructuring Mechanism allows banks to ease terms on loans without setting aside provisions. What’s more, banks are being flexible with many loans — including $4 billion to Air India and $5.5 billion to loss-making state electricity boards — without either formally classifying these as NPAs or ushering them through the formal mechanism.

Meanwhile, evergreening, where banks lend additional money to keep stressed borrowers from defaulting, is common practice. Property experts Knight Frank estimate that at least a tenth of real estate loans are stressed, more than twice the three to four per cent cited by banks. The level of NPAs on infrastructure lending, around half a per cent of total loans, looks suspiciously low, since these loans have increased from 7 to 15 per cent of the banks’ overall loan books since 2007.

The low level of reserves at Indian banks may be encouraging them to fudge the numbers. Most banks reported allowances of less than the RBI’s minimum of 70 per cent of probable losses on total NPAs. At 69 per cent, Indian banks’ average level of reserves of bad loans is far below China’s 252 per cent and Indonesia’s 212 per cent. Setting aside greater provisions will hurt the banks’ bottom lines. But without a bigger buffer, the banks’ bad habits will only worsen.