Indian Banking sector challenged by domestic, not global, factors

October 14, 2008: CRISIL believes that the Indian banking system is relatively insulated from the factors leading to the turmoil in the global banking industry. Further, the recent tight liquidity in the Indian market is also qualitatively different from the global liquidity crunch, which was caused by a crisis of confidence in banks lending to each other. Says Roopa Kudva, Managing Director and Chief Executive Officer, CRISIL, “While the main causes of global stress are less relevant here, Indian banks do face increased challenges due to domestic factors. The banking sector faces profitability pressures due to higher funding costs, mark-to-market requirements on investment portfolios, and asset quality pressures due to a slowing economy.” CRISIL views the strong capitalisation of Indian banks as a positive feature in the current environment.

The problems of global banks arose mainly due to exposure to sub-prime mortgage lending and investments in complex collateralised debt obligations whose values have seen sharp erosion. Globally, banks have also been affected by the freeze in the inter-bank lending market due to confidence-related issues. On both counts, Indian banks have limited vulnerability.

Indian banks’ global exposure is relatively small, with international assets at about 6 per cent of the total assets. Even banks with international operations have less than 11 per cent of their total assets outside India. The reported investment exposure of Indian banks to distressed international financial institutions of about USD1 billion is also very small. The mark-to-market losses on this investment portfolio, will, therefore, have only a limited financial impact. Indian banks’ dependence on international funding is also low.

The reasons for tight liquidity conditions in the Indian market in recent weeks are quite different from the factors driving the global liquidity crisis. Some reasons include large selling by Foreign Institutional Investors (FIIs) and subsequent Reserve Bank of India (RBI) interventions in the foreign currency market, continuing growth in advances, and earlier increases in cash reserve ratio (CRR) to contain inflation. RBI’s recent initiatives, including the reduction in CRR by 150 basis points from October 11, 2008, cancellation of two auctions of government securities, and confidence-building communication, have already begun easing liquidity pressures.

The strong capitalisation of Indian banks, with an average Tier I capital adequacy ratio of above 8 per cent, is a positive feature in their credit risk profile. Nevertheless, Indian banks do face challenges in the current Indian economic environment, marked by a slower gross domestic product growth, depressed capital market conditions, and relatively high interest rate regime. The profitability of Indian banks is expected to remain under pressure due to increased cost of borrowing, declining interest spreads, and lower fee income due to slowdown in retail lending. Profit levels are also likely to be impacted by mark-to-market provisions on investment portfolios and considerably lower profit on sale of investments, as compared with previous years. Moreover, those Indian banks considering accessing the capital markets for shoring up capital adequacy may be forced to curtail growth plans, if capital markets remain depressed.

Says Raman Uberoi, Senior Director, CRISIL Ratings, “While these challenges will play out over the medium term, CRISIL expects the majority of Indian banks’ ratings to remain unaffected, as they continue to maintain healthy capitalization, enjoy strong system support and benefits of government ownership in the case of public sector banks.”

(This is press release of CRISIL)

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