Concerns over banks’ deteriorating asset quality - RBI report on financial stability

India’s financial system remains stable, but the deteriorating asset quality of banks will pose a challenge, the Reserve Bank of India (RBI) said in its report on financial stability released on 28th Dec 2012. This is the central bank’s second financial stability report. The first, released in June, also highlighted the RBI’s concerns over banks’ deteriorating asset quality.

At the end of September, gross non-performing assets (NPAs) were up 45.7% on year, far outpacing the 16% growth in gross advances during the same period. The macro stress test of sectoral credit risk carried out by RBI revealed that agriculture is likely to see the most NPAs by March, at 5.8% of the total advances, followed by engineering (4.7%), iron & steel (4.7%) and construction (3.7%).

Aggressive lending by banks in the past, banks not exercising oversight on diversification into non-core areas by companies, banks not enforcing discipline on companies regarding unhedged forex exposures and delay in disbursements are areas on which banks ought to exercise much better control, the report said.

Slowing economic growth and high borrowing costs have made it difficult for many Indian debtors to repay their loans, causing bad loans to pile up and banks to set aside more money to cover the risk of default. In the fiscal first half ended September, gross non-performing advances of all banks rose sharply to 3.6% of total advances, from 2.9% a year ago.



The banking regulator is also concerned about the expansion in banks’ restructured advances. Between March 2009 and March 2012, while total gross advances of the banking system grew by less than 20%, their restructured standard advances grew by over 40%, the report said.

Worsening credit quality, in turn, could impact banks’ profitability, the central bank said. Their net interest margins (NIMs) would be affected by lower yields on assets, which would offset the benefit of a possible decline in the cost of funds. At the system level, NIMs were about 3%, RBI said.

The banking regulator flagged the declining provisioning coverage ratio. In the second quarter, provisioning coverage levels of some public sector banks were seen falling below 60% from the 70% stipulated in September 2010.

In view of this, it may be advisable for banks to increase their provisioning levels, adds RBI Report.

TO JOIN THE EXCLUSIVE "THE BANKERS CLUB" ... Click here