Bad loans cast long shadow over Indian banks

July 16, 2013 3:01 pm

Bad loans cast long shadow over Indian banks

By James Crabtree

System is left vulnerable to setbacks such as this week’s liquidity tightening

Growing concerns about bank asset quality, hidden bad loans and a general lack of transparency, all set against the backdrop of an economic slowdown. This may sound like a description of worries about China’s shadow banking system. But it could equally apply to the increasingly parlous situation in India too. Politicians in Asia’s second-largest emerging economy often talk with pride about their banks, which are typically cautious and well capitalised. Most made it through the global financial crisis with little difficulty. But signs of stress have become unmistakable over the past year, in particular among the same supposedly reliable state-backed institutions that control about three-quarters of banking assets. And they are getting worse. Tuesday’s sudden moves by the Reserve Bank of India to tighten liquidity, designed to stem recent falls in the rupee, only deepened the problem.The intervention sent bank stocks down about 5 per cent, partly because it limits their short-term borrowing, but more generally because it is likely to cut India’s already faltering growth rate. This, in turn, may increase rates of problem loans.

Ostensibly, the shadow that such bad assets now cast over Indian banks stems from only a handful of high-profile disasters, such as bankrupt airline Kingfisher, ora plethora of stalled infrastructure and power projects.

But, in truth, the problems are deeper in three respects.

First, non-performing assets continue to rise across many sectors, growing to 3.5 per cent of loans at the end of the last financial year, according to CRISIL, a rating agency.

India’s economy shows few signs of picking up either, even before the RBI’s intervention on Tuesday, meaning that most analysts think NPA levels will keep rising this year as well.

Second, and more alarmingly, levels of “restructured” assets are rising still faster. This category, now accounting for roughly 6 per cent of loans, is designed to give breathing room to solvent companies in temporary financial difficulty. But it is an open secret that restructuring is being misused by banks to disguise many debts that are unlikely ever to be repaid.

Figures from ratings group Fitch reveal the scale of the problem. The combination of bad and restructured debts will reach just under 12 per cent of loans, or Rs3.5trn ($60bn), by next April, a level that has nearly doubled in just two years.

“Twelve per cent is a scary number. Something clearly needs to be done about it,” says Ananda Bhoumik, a director at Fitch.

Underlying all this is a third concern, namely that many bad debts are yet to be recognised at all. “India has a major problem with zombie companies surviving on drip funding from the banks,” says Sanjeev Prasad, head of research at Kotak, a broker. “One can be reasonably confident the problem is far bigger than what the banks report.”

India’s surprisingly weak growth over the past year is partly the cause of this problem, but bankers must share the blame too. A cosy system has developed in which banks act with excessive generosity towards borrowers, with the tacit approval of policy makers.

As Aditya Puri, the head of HDFC Bank, one of India’s most admired private sector lenders, told the Financial Times this year: “You either lend to highly leveraged industrial conglomerates or you don’t. And we haven’t.”

Too few of his peers take the same view.

The result is an epidemic of moral hazard across much of India’s corporate sector, led by some prominent tycoons who take a slapdash approach to risk, safe in the knowledge that any rash behaviour will be forgiven.

This is unlikely to lead to a systemic crisis. India’s banks remain adequately capitalised and profitable, especially the private sector institutions. The RBI, meanwhile, has recently tightened some rules on restructured loans.

But it does mean that India’s banking system is more vulnerable to setbacks, such as Tuesday’s liquidity tightening, while bad loans will continue to weigh on share prices and profits, especially at state-backed groups.

More importantly, when the economy eventually does recover, banks will be less able to lend to those who need it, as they try to clean up the mess on their books.

Ultimately, the lasting solution is for bankers to classify assets more honestly, while also taking a tougher attitude to struggling companies. Until they do, the shadow of undisclosed bad loans hanging over India’s banks is unlikely to clear.

James Crabtree is the Financial Times’ Mumbai correspondent

About bambooinnovator
Kee Koon Boon (“KB”) is the co-founder and director of HERO Investment Management which provides specialized fund management and investment advisory services to the ARCHEA Asia HERO Innovators Fund (, the only Asian SMID-cap tech-focused fund in the industry. KB is an internationally featured investor rooted in the principles of value investing for over a decade as a fund manager and analyst in the Asian capital markets who started his career at a boutique hedge fund in Singapore where he was with the firm since 2002 and was also part of the core investment committee in significantly outperforming the index in the 10-year-plus-old flagship Asian fund. He was also the portfolio manager for Asia-Pacific equities at Korea’s largest mutual fund company. Prior to setting up the H.E.R.O. Innovators Fund, KB was the Chief Investment Officer & CEO of a Singapore Registered Fund Management Company (RFMC) where he is responsible for listed Asian equity investments. KB had taught accounting at the Singapore Management University (SMU) as a faculty member and also pioneered the 15-week course on Accounting Fraud in Asia as an official module at SMU. KB remains grateful and honored to be invited by Singapore’s financial regulator Monetary Authority of Singapore (MAS) to present to their top management team about implementing a world’s first fact-based forward-looking fraud detection framework to bring about benefits for the capital markets in Singapore and for the public and investment community. KB also served the community in sharing his insights in writing articles about value investing and corporate governance in the media that include Business Times, Straits Times, Jakarta Post, Manual of Ideas, Investopedia, TedXWallStreet. He had also presented in top investment, banking and finance conferences in America, Italy, Sydney, Cape Town, HK, China. He has trained CEOs, entrepreneurs, CFOs, management executives in business strategy & business model innovation in Singapore, HK and China.

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