Resist bailouts

Growing stress on Indian banks

The combination of the credit squeeze and the falling rupee has already impacted the banking sector in multiple ways. If this continues, which seems likely, it could lead to severe deterioration in bank balance sheets or even a full-blown crisis. Rising bond yields have already led to capital losses, which must be marked to market. The Reserve Bank of India (RBI) estimates that the banking system needs an additional Rs 30,000 crore of marked-to-market provisioning for every percentage point rise in bond yields. The benchmark 10-year government bond has risen by about 150 basis points since end-June, which implies Rs 45,000 crore or more of marked-to-market provisioning. This will come straight from bottom lines. The concomitant rise in interest rates has raised the cost of capital and also retarded credit demand. Banks have started raising deposit rates and they are paying 300 basis points above the benchmark repurchase rate for loans from the RBI's marginal standing facility. More loans are bound to go sour in the current environment of slow growth. As it stands, gross non-performing assets (NPAs) and restructured loans in combination stood at above nine per cent of all assets at end-March 2013. At that time, net NPAs were around 1.6 per cent. Both NPAs and restructurings grew substantially in the April-June 2013 quarter and Crisil estimates net NPAs will rise in this fiscal to three per cent or more. Public sector banks, which hold about 70 per cent share of the banking system, are particularly worse off.

Rupee depreciation adds another level of difficulty. Companies are finding it difficult to service overseas debt in the face of rupee depreciation. External commercial borrowings amount to about $170 billion, with about $20 billion due for repayment this fiscal. There are also as many as 40 issues of foreign currency convertible bonds already past due dates with over $2 billion outstanding in redemption demands. Between a third and two-thirds of such exposures are unhedged against currency risk, and foreign branches of Indian banks also have exposures to such instruments. The RBI is also committed to meeting Basel III norms in a staggered fashion over the next five years. Banks must raise at least Rs 5 lakh crore in tier-one capital, including nearly Rs 4 lakh crore from the government if it wishes to maintain its current stakes in PSU banks. As NPAs rise and profitability is hit, the need for recapitalisation will also rise. The Basel III timetable may need to be reworked.

What would cause real trouble is if banks are asked to do the politically expedient thing and help defaulting corporations meet overseas obligations. The central bank will have to resist such pressures and shield the commercial banking system as far as possible. Corporate bankruptcies and defaults, whether in rupees or in dollars, are liable to be less damaging than the alternative scenario of bailing out sick banks. The RBI needs to deploy all its skills and assert its independence to stem the rot in what is fast turning into an "annus horribilis" for the banking system.