Banks must avoid rise in NPAs: Reddy

The Reserve Bank of India RBI governor, YV Reddy,  has cautioned commercial banks against rising non-performing assets (NPAs) in their home loan portfolios with the rise in interest rates.

However, such an event is unlikely to have systemic ramifications, as "the banking sector's exposure to housing loans overall is relatively small," Reddy said while dwelling on the possible impact of global imbalances in a key note address at the United Nations in New York yesterday.

The Indian banking sector disbursed a total of around Rs 80,000 crore of loans for home purchases in 2005-06. As on January 20, 2006, the outstanding home loans amounted to Rs 1,66,159 crore. The total non-food credit totalled Rs 12,56,368 crore.

Any abrupt adjustment in global imbalances may affect corporates, banks and households in India though the impact may be less than some other emerging economies, Reddy said.

With respect to the impact on corporates, if there is widening of spreads due to a shift in investor confidence in the international markets, those corporates which have borrowed at variable rates may possibly suffer more than those, which have taken loans on a fixed rate basis. Corporates which have hedged against currency and interest rate risks may escape the adverse effects.

The Reserve Bank has been urging banks to encourage corporates to hedge their foreign currency exposures. Further, exposure of the corporate sector as a whole to the external debt is limited by indicative ceilings on external commercial borrowings imposed by the government and the RBI. The level of total external debt of India is currently less than the foreign exchange reserves.

Although banks in India have their deposit base predominately in rupees and their investment in foreign currency assets is not large, they have been financing investment in assets, home loans and the retail market as well as equities.

Like in many emerging market economies (EMEs), asset prices have risen sharply in India too. Should there be a reversal of capital flows, asset prices may decline but banks' exposure to the risky assets have been severely restricted by RBI's regulatory actions.

Further, banks in India have invested significantly in government debt and other fixed income securities. If a rise in international rates gets reflected in domestic interest rates, banks will have to mark down the value of their investment portfolio. To the extent a rise in international interest rates impacts the domestic interest rates, it would entail marked-to-market losses on the investment portfolios.

The RBI governor said the banking sector has, however, acquired some added strength to absorb such probable shocks, largely aided by regulatory actions.

The developments in the currency and capital market are intrinsically
intertwined with the global imbalance and, therefore, in the eventuality of a disorderly correction, disruption in these markets in the form of large cross-currency volatility and sharp rise in interest rates are likely in the global economy.

Since India does not depend on the international capital market for
financing the fiscal deficit and consequently to some extent adverse
consequences of the less than orderly adjustment of global imbalances on the Indian economy would be muted.

However, there could be a spill-over effect of global developments on domestic interest rates and thus on government finances also. The fiscal position of the government could also be indirectly impacted through the nature of management of foreign exchange reserves held by the RBI.