Financial Stability Report warns of cascading effect of default

Banks are more at risk now than six months ago with a jump in bad loans and a rise in the number of loans restructured by stressed companies.

According to the Reserve Bank of India’s latest Financial Stability Report, the inter-linkages among banks heighten the risk in case even one large corporate falters in keeping up with the debt repayment schedule.

“The Banking Stability Index (BSI), which measures the expected number of banks that could become distressed given that at least one bank becomes distressed, has risen sharply since August 2013,” the report said. It did not, however, mention the number of banks that would be affected.

In his introduction to the report, RBI Governor Raghuram Rajan said that the stress test assumes extreme conditions but shows that the financial system in India is resilient to pressures at this point in time but there is a need to be vigilant.

Contagion problem

The report said that a large loss caused by a corporate to a bank may not be restricted to that lender alone. It can distress the entire system. “If, in the case of one or more banks, the loss is large enough to cause distress to the bank, there will be further losses (to the entire banking system) due to the contagion caused by the distressed bank,” the report warned.

For instance, if the bad loans double for a large bank, the additional losses to the banking system would increase by 26.8 per cent of the total capital. The RBI also admitted that part of the problem was banks’ large exposures to big corporates.

“In the Indian context, a bank’s exposure to a single borrower can go up to 25 per cent of the bank’s total capital, while its group exposure limit can go up to 55 per cent of the bank’s total capital. These exposure norms have evolved in the context of the country’s growth and development requirements, but are on the higher side by international standards,” cautioned the report.

The RBI said five sectors — infrastructure, iron and steel, textiles, aviation and mining — account for about 24 per cent of the total advances of Scheduled Commercial Banks, and account for around 51 per cent of their total stressed advances.

On the broader economy, the RBI Governor said that the outlook had improved, with exports gaining momentum. “It is imperative that long-delayed legislative reforms are pushed through, stalled infrastructure project clearances continue and fiscal consolidation remains on track in order to maintain the momentum.”

Broader economy

In the second quarter of the current fiscal, India’s GDP grew 4.8 per cent against 4.4 per cent in the previous quarter. He said high inflation has meant that there is limited room for cutting interest rates to boost growth. In addition to the US Fed’s tapering over the next year, a potential source of uncertainty in India would be the next year’s general elections. “A stable new government would be positive for the economy,” he said.

satyanarayan.iyer@thehindu.co.in

(This article was published on December 30, 2013)
XThese are links to The Hindu Business Line suggested by Outbrain, which may or may not be relevant to the other content on this page. You can read Outbrain's privacy and cookie policy here.