RBI working paper warns of further strains in asset quality of banks

The RBI working paper titled, “Re-emerging stress in the asset quality of Indian
 banks: Macro-financial linkages,” said if the current adverse macro-economic 
condition persisted, the system level gross NPA (non-performing assets) 
ratio could rise to 4.4 per cent by end-March 2014. File photo

 KT J  :T H :February 7, 2014

Growth prospects in the near-term seemed to have subdued

A Reserve Bank of India (RBI) working paper has warned banks of further strains on their asset quality.

The working paper titled, “Re-emerging stress in the asset quality of Indian banks: Macro-financial linkages,” said if the current adverse macro-economic condition persisted, the system level gross NPA (non-performing assets) ratio could rise to 4.4 per cent by end-March 2014. This ratio could go up to 7.6 per cent under the severe risk scenario, it added.

Public sector banks, it said, might continue to register highest NPA ratio.

The growth prospects in the near-term seemed to have subdued, it said. “In October 2013, the IMF (International Monetary Fund) scaled down its projection of world GDP (gross domestic product) growth for 2013 to 2.9 per cent. In its First Quarter Review of Monetary Policy 2013-14, the RBI has also revised its growth projection for 2013-14 downwards to 5.5 per cent,” it added. While the credit growth in the recent period had ebbed, the RBI projected the non-food credit growth to be around 15 per cent in 2013-14. “Thus, notwithstanding the fact that credit growth is not going to be significantly robust, muted economic prospects and global headwinds could lead to further deterioration in asset quality,” the RBI working paper said.

“The position is not alarming at the current juncture, and some comfort is provided by the sound capital adequacy of banks, which ensure that the banking system remains resilient even in the unlikely contingency of having to absorb the entire existing stock of NPAs,” the RBI paper said.

Stress tests

The stress tests for banks showed that even under a scenario in which 30 per cent of restructured advances became NPAs, bank stress remained contained, and banks sufficiently capitalised.

Nevertheless, the RBI working paper suggested that “it is worth to recognise the problem in its early stages, and initiate corrective measures in the right earnest”. Though restructuring of advances was helpful in containing the effect of rising bad loans in banks’ balance sheet, in the long-run, however, it could have implications for asset quality of the banks just in case a significant proportion of these restructured advances turned out to be bad loans.

“Hence, there is a need to carefully monitor the impact of restructuring on asset quality of banks in the medium- to long-run,’’ the working paper said.

The spurt in NPAs, it said, was due to assorted factors ranging from inadequate appraisal and monitoring of credit proposals to aggressive lending, among others. “Delay in administrative clearances was an equally important reason for pressure on asset quality which needed correction, it pointed out. “There is a need to strengthen oversight of financial and corporate risks, and policies to incentivise genuine corporate restructuring and improvements to insolvency framework,” the working paper said.

Trends revealed that though public sector banks contributed to the bulk of NPAs. The share of new private sector banks, and foreign banks in the total NPAs had gone up in the post-crisis period. “Nonetheless, public sector banks and foreign banks have mainly contributed to the recent rise in NPAs. Public sector banks and old private sector banks have witnessed greater deterioration in their asset quality in the case of priority sector, while it is vice-versa in the case of foreign banks and new private sector banks,” the paper pointed out.

Other industries

If one were to go by the RBI working paper, coal and textiles had contributed substantially to the recent deterioration in asset quality. The other industries that contributed to the rise in NPAs included iron and steel, other textiles, jute textiles, cotton textiles, computer software, leather and leather products, sugar, tobacco, rubber, metals, construction and vegetable oils and vanaspati industry.