RBI permits banks to use buffer to cover bad loans

In allowing banks to use a part of these reserves, RBI is implicitly acknowledging
 that mounting bad loans are a systemic concern for the banking sector in
 Asia’s third largest economy. Photo: Pradeep Gaur/Mint

LIVE MINT : Dinesh unnikrishnan FEB 07 2014. 10 48 PM IS

The Reserve Bank of India (RBI) on Friday allowed banks to use up to one-third of the amount banks have set aside as countercyclical buffers to make provisions on bad loans.

Countercyclical provisioning buffers and floating provisions broadly refer to the capital reserves that banks need to build in good times; these are used only in times of economic or system-wide downturns.

In allowing banks to use a part of these reserves, RBI is implicitly acknowledging that mounting bad loans are a systemic concern for the banking sector in Asia’s third largest economy.

This is the first time the Indian central bank is allowing banks to use emergency provisions ever since the reserves were created starting 2010.

By definition, banks can use such provisions only for contingencies under extraordinary circumstances for making specific provisions against impaired accounts after obtaining their board’s approval and with the permission of the central bank.

Also, the boards are required to lay down an approved policy regarding the circumstances that would be considered extraordinary.

“It has been decided, as a countercyclical measure, that banks may utilize up to 33% of countercyclical provisioning buffer, floating provisions held by them as on 31 March 2013, for making specific provisions for non-performing assets, as per the policy approved by their board of directors,” RBI said in a notification on Friday.

Although the creation of such a reserve was under discussion since 2006, banks started building up the reserves only in 2010.

Mounting bad loans have been a major worry for the Indian banking system, especially since the 2008 global financial crisis that followed the collapse ofLehman Brothers Holdings Inc. in late 2008. By conservative estimates, the Indian banking system has about Rs.2 trillion in bad loans, and another Rs.4 trillion loans are being restructured, together constituting about 10% of the total loans of Indian banks.

The increase in such loans hurts the profitability of banks since they need to set aside more money to cover for the souring assets.

Gross non-performing assets (NPAs) of 35 listed banks rose 39.4% in the December quarter to Rs.1.71 trillion from Rs.1.23 trillion in the year-ago period, according to data sourced from Capitaline.

Banks with the highest level of bad loans are United Bank of India (10.2%),State Bank Of India subsidiaries State Bank of Mysore (6.56%) and State Bank of Hyderabad (5.77%); Allahabad Bank (5.47%); Indian Overseas Bank (5.27%); and Uco Bank (5.2%)

State Bank of India, the country’s largest lender, will announce its earnings on 14 February.

Recently, RBI laid out a road map to deal with the surge in bad loans in theRs.82 trillion banking system, through early recognition of stressed assets.

Analysts, however, are sceptical about this road map saying it doesn’t address the issue of the existing stock of bad loans.

The framework outlines a corrective action plan that would give incentives for early identification of stressed assets by banks, timely restructuring for accounts considered to be viable, and prompt steps for the recovery or sale of assets in the case of loans at the risk of turning bad.

It also proposed accelerated provisioning in cases where banks fail to come up with a recovery plan.

On Friday, RBI said utilization of the countercyclical provisioning buffer and floating provisions will be over and above the utilization of the countercyclical provisioning buffer and floating provisions for the purpose of making accelerated additional provisions under the recent framework.

India Ratings and Research Pvt. Ltd, an arm of global credit rating agencyFitch, last week warned that stressed assets, which include bad loans and restructured loans, in the Indian banking system are likely to increase to 14% of total loans by March 2015.