Dinesh Unnikrinan : FP : Nov 5,2014
The rating downgrade effected by Standard and Poor’s on state-run lender, Indian Overseas Bank (IoB) is yet another strong warning to the Modi government about what is possibly in store in the ensuing years — worsening financial position and a bigger crises in government banks.
S&P downgraded the long-term credit rating of IoB to BB+ speculative grading in the face of recent deterioration in the bank's asset quality. IoB’s gross non-performing assets (NPAs) shot up to 7 percent in the September quarter from 5 percent in the March quarter.
Besides, the chunk of total standard restructured loans on the books of the bank too has surged to close to 8 percent in the quarter, which means a significant chunk of the assets in IoB’s is now under the stressed asset category.
According to officials at the agency, IDBI Bank is the only lender it rates that carry a BB+ rating.
Typically, long-term instruments of state-run banks are accorded rating at par with the sovereign rating given that these entities enjoy the backing of the sovereign. In rating parlance, BB+ is speculative or junk grade.
For practical reasons, a junk rating would mean a sharp rise in the borrowing costs of the firm concerned and risk aversion from the investors, besides being an indicator of trouble in the balance sheet. Kolkata-based United Bank of India, which had seen its gross NPAs surging to double digits early this year, is not covered by S&P.
At least five state-run banks have their gross bad loan levels above 5 percent of their total loans now. Some of them are facing immense stress on account of an equal rise in the restructured loan portfolios as well. Restructured loans are loans of troubled borrowers, which seek relaxed repayment terms from banks.
Currently, about Rs 2.5 trillion of the loans given by banks are bad and about Rs 5-6 trillion are being recast under various channels.
The situation is unlikely to get better any time soon. On Tuesday, rating agency, India Ratings, formerly known as Fitch India, said India's banking system is likely to witness a surge in restructured assets by a whopping Rs 60,000 to Rs 1,00,000 crore over the next five months.
"We expect the restructured assets in the banking system to shoot up by another Rs 60,000 crore to Rs 1 trillion over the next five months," India Ratings senior finance director Deep N Mukherjee said.
Such a rise in the bad and restructured loans could significantly add up to the capital burden of banks since current norms require banks to set aside substantial amount of money to cover stressed assets.
Capital burden arising out of bad loans is just one side of the story. State-run banks also require about Rs 2.5 trillion capital to meet the Basel-III capital norms.
Any respite in the stressed asset situation can happen with a lag—that too if economic revival takes strong hold, projects come back on track as and when investments return to the country and procedural roadblocks are removed. Until then, stress in the banking system is a hard reality before the Modi-government to deal with.
The financial burden will ultimately fall upon the government, which is the owner of state-run banks. The government infuses capital into state-run banks on an annual basis.
For the current fiscal, the budgeted allocation is Rs 11,200 crore. That would be just a fraction of what is actually required considering the growing capital requirement, even with a longer deadline to comply with Basel-III rules.
Going ahead, a capital constrained government will find it extremely difficult to continuously feed state-run banks with taxpayer’s money. The solution, as FirstBiz has highlighted before, is in privatizing public-sector banks and leaving the competition to the market. The government has no business to be in business.
Modi, who has positioned himself as the agent of change, shouldn’t shy away from uttering the P-word any more. The process could begin with small and medium sized banks that are financially weak.
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