Bank NPAs may rise on retail loan defaults

Public sector banks are likely to see an increase in their level of bad loans over the next three years to 4-5.5 per cent from 2.8 per cent at the end of March 2007 on account of higher defaults in their retail and corporate portfolios, according to a report by ratings firm ICRA.

Consequently, the banks may have to make 100 basis points higher incremental provisioning over the medium term to maintain their net non-performing assets (NPA) levels reasonably low.

The fresh slippage rate is expected to be at around 2-3 per cent of advances, against 1.77 per cent at the end of 2006-07, resulting in the gross NPA level moving up to 4-5.5 per cent by March 2010. 

TREND IN PSBs ASSET QUALITY
In %	Fresh NPA generation rate	Gross NPA	Reduction in NPAs	Growth in net advances
2000-01	4.12	12.40	13.00	17.00
2001-02	2.49	11.10	14.00	16.00
2002-03	3.37	9.40	32.00	14.00
2003-04	3.46	7.80	38.00	23.00
2004-05	2.46	5.50	39.00	27.00
2005-06	2.00	3.70	45.00	29.00
2006-07	1.77	2.75	51.00	30.00
Source: Reserve Bank of India and ICRA's estimates

"Going forward, while improvements in risk management would help the banks control asset quality, some stress may be visible in their retail as well as corporate portfolios," said the report.

Housing loans, which account for half of the retail advances, are likely to see higher defaults as public sector banks increased the equated monthly instalments following a rise in interest rates.

Other retail advances could also see higher defaults as banks continue to leverage certain borrower classes and there is lower underwriting of risks and slackening of credit monitoring.

There could be a moderate deterioration in the credit profile of corporate borrowers despite a favourable business environment, said the report.

This is on account of higher leveraging and project risks arising out of aggressive expansion. Besides, high-value acquisitions adversely impact the cost competitiveness of corporates and their capital structures.

The deterioration in global economic environment could lead to the rupee strengthening against major foreign currencies and a lowering of import duties, adversely affecting corporates. The higher interest rates and refinancing risks owing to tight liquidity conditions could also impact lower-rated corporates.

According to ICRA's estimates, though the recoveries from existing NPAs have been at 25-30 per cent, over the last two years, due to an improved regulatory environment, this could decline to about 20 per cent over the medium term, owing to a stagnation in collateral values and stickiness in remaining NPAs.

Indian banks had recovered Rs 16,500 crore in the three years ended March 2006, mainly through recourse to debt recovery tribunals and provisions of the SARFAESI Act.

To maintain their net NPA level at reasonably low levels, the incremental provisioning could increase to 100 basis points (in relation to net advances) for the banks over the medium term. This would help the banks maintain their solvency ratio (percentage of net NPAs to net worth) in the range of 10 -20 per cent.

The banks would have to look at improving their core profitability and bringing down losses in their fixed income portfolios, to absorb the expected increase in credit provisions, said the report.

"Assuming credit at around 65 per cent of the total assets, the increased credit provisioning alone would dilute the pre-tax earnings of PSBs by over 50-65 basis points over the medium term as against only 35 basis points in 2006-07," said the report.