Weaknesses cannot be wished away: S&P

ANALYST'S VIEW

The banking sector in India is highly fragmented, with 53 domestic banks accounting for about 93 per cent of the assets. Considering that the top 10 banks account for 66 per cent (as on March 31, 2006), the remaining 27 per cent of the market is shared between 43 banks.

The banking business benefits from scale, especially with the increasing role of marketing and technology-based systems.

Niche banks can thrive as long as their niche areas are sustainable. With technology-based distribution and superior customer deliverables allowing national banks to permeate the strongholds of regional banks, the later are coming under threat.

While most of the national banks have healthy financial parameters, it is the small players whose profitability and asset quality (non-performing assets) appear weak.

With about three-fourth of the banking systems' assets in the hands of 29 public sector banks, a meaningful consolidation is not possible unless it includes this segment. It is the government that determines the extent and speed of consolidation in the Indian banking system.

Despite an improvement in risk management, the progress is still slow and expected to remain so, especially due to the deferral of the new capital adequacy framework implementation, based on minimum capital requirements under Basel II, to FY 2008.

Banks continue to establish sound risk management practices, but it has been difficult to keep pace with the emerging risks. Despite significant improvements in the past decade, risk management is still largely a work in progress for most Asian systems.

With strong credit growth and weak risk management systems, especially in the smaller banks, there is a high possibility that problem assets may be understated.

As of March 31, 2007, Standard & Poor's estimates that at least 40% of all the loans were less than two years old, raising concerns that, when seasoning occurs, a significant amount of new NPAs could emerge.

The high portfolio growth suppresses the NPA ratios. A steady decline in the lagged NPA (1-year lagged as well as 2-year lagged) indicates that improvements in the portfolio quality are systemic.

In the current economic scenario, the potential for a significant rise in problematic assets seems low. In the event of an economic slowdown, the rise could be pronounced.