Indian Banks Ride the Growing Economy, Though Cyclical Downsides Visible

20 August 2007: Fitch Ratings today commented that the strong domestic franchise and reach of the larger Indian banks have helped them exploit the growth opportunities in a rapidly expanding Indian economy. The Indian banks have also effected structural improvements in their risk management capabilities and raised capital from the buoyant domestic and international capital markets. While the benign credit cycle helped support the improved performance, the rising interest rate cycle together with rapid loan growth have now exposed banks to growing non-performing loans (NPLs). The more vulnerable asset categories, including unsecured consumer loans, capital market exposures and real estate lending, however, comprise less than 10% of total loans. The median net NPL/equity ratio (less than 10% in FY07) is therefore unlikely to rise sharply. As such, Fitch views that the rating Outlook for the sector remains Stable.

In a Special Report on the Indian Banking System, Fitch observes that Indian banks would remain the dominant financial intermediary in an economy characterised by relatively low credit penetration (percentage of bank loans to GDP was around 50% in FY07). The sector is regulated and extensively monitored by Reserve Bank of India (RBI), who has gradually tightened prudential norms and has been introducing international disclosure and accounting standards. Exposure to the overseas market have been limited, and the relative insulation of the Indian banking system together with the close supervision by RBI has helped to avoid any crisis. Creditor rights have been improving and while an auction market for distressed assets will take a while to be established, banks have been able to increase recoveries from delinquent accounts through negotiated settlements. The continued pace of financial reforms has also resulted in the development of new institutions for clearing and settlement of debt market transactions, foreign exchange and derivative instruments, credit information bureaus and asset re-construction companies that have strengthened the financial system and improved its efficiency.

Challenges abound - particularly in maintaining profitability even as rising interest rates start to affect the borrower's repayment capacity. The need for infusing further capital will also remain strong. The government's holding in many of its banks is close to the statutory minimum of 51%, which restricts the ability of these banks to raise further equity. Global liquidity had tightened in recent weeks; Indian banks reportedly has no exposure to the US sub prime market and limited investments in CDS (primarily that of Indian entities), with manageable mark-to-market losses. The widening spreads would however, increase the cost of the popular hybrid Tier 1 and Tier 2 capital; any sustained deterioration in global liquidity could also affect growth prospects.

(This is the press release of Fitch Ratings)

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