Quality of Bank Credit in India

Quality of Bank Credit in India

A lot of talk about India being one of the best emerging economies in in the world and a stand out economy compared to the rest of the world and projected as replacing China in terms of growth and world trade.

With the government perusing new policies and with a boost to many sectors and policy frame work like “Make in India “, Indian economy is projected to grow at a rapid pace. In order to growth the most important aspect is to have easy access to credit and a reasonable rate. Bank credit in India is still not very easy to get and with the conservative approach of the bankers in India the overall leverage provided by the banks is very modest compared to international standards.

One of the reasons the banking system stood strong in the 2008 crises is the limited leverage given to the companies and superior asset quality mainly due to stringent credit appraisal and quality selection of the borrower. However there is a big question today on the actual quality of the books in the banking system and the statics hide more than they reveal due to smart accounting methods like ever greening of loans, reconstruction of loans and loan top ups.

A big question is been asked about the true picture of the economy and more important the asset quality of most banks with reverence to statistical secret over stressed bank loans

Look around Asia for questionable economic figures and it is hard to get beyond China. Officially, the continent’s largest economy grew at 7 per cent in the first half of this year, bang in line with government targets. But many observers are suspicious, suspecting that creative accounting is hiding a sharp slowdown in growth.

Viewed from Mumbai or New Delhi, these China doubts are met with worries over their effects on India’s corporate sector, but also happy anticipation that the title of fastest-growing big global economy may be about to change hands. Yet anyone in India feeling an early sense of superiority would do well to remember that India has its own dirty statistical secret: a rate of troubled bank loans that is almost certainly in worse shape than government data suggest.

Officially it is bad enough. The Reserve Bank of India says that 11 per cent of loans, worth about $111bn, were stressed at the end of the last financial year. Of this, slightly less than half were non-performing. The remainders have been restructured, for instance by giving errant borrowers extra time to pay. Both measures have risen steeply over recent years, although the problem is most severe at state-backed banks, where 14 per cent of loans are stressed.

The true figure is probably even worse. Almost every big Indian industrial company has suffered delays to investment projects in recent years, including those of prominent businessmen. But a handful of sectors have been hit by even bigger problems. Steelmakers are suffering from a collapse in global commodity prices. Power producers are struggling to find buyers at bankrupt Indian state electricity boards.

 Despite this, most loans at heavily indebted metals and power companies are yet to be labeled as stressed. This year proper recognition of bad steel debts alone would push India’s non-performing assets levels up by nearly a third.

About $60bn of debts in the hands of businesses that have not earned enough to pay their loan interest for three years or more — a clear indication that repayment is unlikely. Despite this, 92 per cent of those same loans are still classified as healthy.

Tallying up figures like this is not easy and definitive figure for India’s true level of non-performing loans. But the research suggests it would be in the high teens rather than the official 11 per cent.

The significance of this is obvious. India’s economy appears to be recovering nicely, expanding at 7 per cent over the last quarter, the same rate as China. But underlying credit growth has stayed mysteriously low as banks shy away from lending, aware of the true problems in their loan books. In time, this will to choke off growth and most medium size companies find it extremely difficult to raise money from banks and financial institutions. 

It also means greater recapitalization. As part of plans to meet new Basel-III capital requirements, government last month announced it would inject Rs700bn ($11bn) during the next four years into state-owned lenders, which control about three quarters of loans. But a recent analysis from India Ratings, a division of Fitch, suggests that Rs1tn ($15bn) will be needed over and above that level to cover unrecognized bad loans across the banking system.

This cash is required because India’s bankers have been optimistic. They hope all those troubled steel and power projects will come good, and have given borrowers more time to recover — a sanguine policy that critics might describe as extend and pretend. But even if these projects do get finished eventually, many will remain unviable without loan haircuts, a step India’s banks have so far been unwilling to contemplate.

The RBI Governor has tightened some rules, forcing banks to put more money aside to cover loans that may go bad.  Whatever measures are taken, admitting the scale of India’s bad loans is a necessary start. As China might be about to discover, it is hard to fix a problem without it admitting it first.

-       Farzan Ghadially