Rising Npas Set Alarm Bells Ringing

The issue of rising non-performing assets (NPAs) in the Indian financial sector has topped the list of concerns for investors. Analysts who have been tracking the sector have adopted a `neutral to negative' outlook for the year.

The increased provisions for NPAs and write-offs among better players has caused worry over the sector's short to medium term performance. "Things are expected to get worse before they get better," a leading international brokerage said.

`Very weak asset quality by international standards, despite continued efforts and some improvement for individual institutions' was listed as a key industry sensitivity by international rating agency Standard & Poor's.

 

With the slowdown in real growth, and the time taken to aggressively diversify into the potent retail finance segment, analysts predicted worsening asset quality and deteriorating financials in the coming two years.

While there was a diversification into fee-based activities, this sector's growth strongly correlates with the real sector's growth.

Almost every financial sector stock is close to its historic low.

Foreign investors are paring exposures to the sector with portfolio investors selling their financial sector scrips. "The economic slowdown has hit every lender. In this environment, asset quality will further deteriorate and investors are resigned to that fact," said Anant Shanbag, analyst at broking house Kotak Securities. "Banks have high exposures to core sectors like iron, steel and cement, which are doing badly. This year slippages (rise in NPAs) have outpaced reductions. Besides, the fairly strong growth in advances is also making the NPA situation look better than what it might be," an analyst with SBI Capital Markets (SBICaps) said. NPAs, always an important concern, became the primary focus after the Asian crisis and the near collapse of the region's financial sector.

"The international investor thinks India could face a similar crisis. Domestic bankers argue their exposure to the property sector (which brought down Asian banks) is fairly low. But they have high exposures to the priority and core sectors," Shanbag said.

Bankers too are concerned. The matter is increasingly being discussed between the Reserve Bank of India (RBI), the government, and industry.

Worst hit will be financial institutions as their have huge long term exposures. The important valuations to an analyst now are gross NPAs, rate of growth of NPAs vis-a-vis rate of growth in advances, operating profits before deductions of NPA provisions, and similar ratios.

The trend towards marking-to-market the investment portfolio is causing further concern as it exposes the bottomline to market vagaries, resulting in volatility in investment income, a major contributor to total income.

"While the introduction of prudential norms saw an improvement in the last five years, these norms are not as stringent as international norms. So you see some players reporting lower NPAs inconsistent with economic fundamentals," the FII brokerage said.

"The NPA problem has not reached a crisis situation. Compared to other Asian economies, Indian banks are a 100 times better. But if the economy worsens, the system could bleed," he added. He said Indian banks were better capitalised and had lower short term liabilities, but the re-structuring process was slow because of the high level of government ownership, the sector's size, and market conditions.