India’s State Banks Need More Medicine

India’s State Banks Need More Medicine

ABHEEK BHATTACHARYA

Nov. 20, 2013 6:56 a.m. ET

India’s state-owned banks need new blood. Weak economic growth has hit these lenders hard. Exposed to politically favored but risky customers like farmers and small businesses, state-owned banks have racked up more than their fair share of bad loans. State banks hold 86% of the system’s bad loans while accounting for 75% of the lending market. To help write off these assets, the government plans to inject $2.3 billion of fresh capital into state-owned banks over the next few months. While this is a step in the right direction, it isn’t enough.

Consider State Bank of India,500112.BY -0.51% the country’s largest by assets. Last week, it reported that bad loans had shot up 19% from a year earlier in the quarter ended September to 5.6% of all loans.

These loans may keep piling up. SBI continues to lend to questionable customers. Power-industry loans grew 42% on a year-to-year basis and iron and steel loans 29% during the September quarter, despite subdued industrial production and structural hurdles in these industries. More reliable borrowers are coming under pressure as bad debts at large companies, so far muted, start to climb.

Then there are SBI’s existing loans that it classifies as “restructured,” easing borrowing terms to avoid classifying them as nonperforming. These made up 3.44% of its loans as of Sept. 30. A chunk could slip into the nonperforming basket.

SBI shares trade below book value, suggesting investors already doubt the value of its assets. Worse, the provisions set aside for bad loans are falling compared with the growth of those loans, and now cover less than half.

SBI is trying to fill the gap. The government will inject $320 million, while management said it would raise roughly $1.3 billion by privately placing shares, diluting existing investors.

With the rising weight of bad loans, more capital-raising may be in order. Nonperforming loans for which SBI hasn’t provided reserves, and restructured loans, add up to $11.4 billion as of Sept. 30. If all these had to be written off, it would eat up 70% of its common-equity base, even after accounting for the new capital.

SBI is probably the best capitalized of India’s state lenders, and others are in more desperate need of funding. Moody’s forecasts state banks may require up to $5.8 billion next fiscal year. Nearly all of this will have to come from the central government or state-controlled investment firms, since the banks will find it hard to access public markets.

Yet like its wards, New Delhi is stretched, too. It will breach its budget-deficit target this fiscal year by at least 10%, says DBS. If the only blood donor around is weak, these banks are bound to be in the intensive-care unit for a while.