Banking on better times

The latest Financial Stability Report (FSR) from the Reserve Bank of India suggests a slow repair of the balance sheets of Indian banks now underway. Between September 2013 and March 2014, the total stressed advances — both non-performing assets (NPA) and restructured loans — of scheduled commercial banks have declined from 10.2 to 9.8 per cent of gross advances. Their average capital to risk-weighted assets ratio (CRAR) has also gone up from 12.7 to 12.9 per cent. These point to the probability that the worst may be over. The rate of slippage of standard loans into NPA category has certainly come down. Coupled with the spurt in sales of bad loans by banks to asset reconstruction companies, there has been an overall improvement in asset quality, albeit marginally.

But the process of gradual repair in the balance sheets and improvement in asset quality has also been attended by shrinkage in credit growth — to below 14 per cent in 2013-14 from an average 17-18 per cent over the preceding five years. To the extent this reflects a conscious effort to pare exposure to troubled sectors and put in place more rigorous credit appraisal systems, this is not necessarily a bad thing. But it is a matter of concern if the room for credit expansion is constrained by capital adequacy. True, the overall CRAR of Indian banks is well above the minimum requirement of 9 per cent. Even in a ‘severe stress’ scenario of GDP growth at 1.7 per cent this fiscal, the ratio will fall to only 10.6 per cent and 9.4 per cent in the case of public sector banks (PSB), according to the FSR. The FSR is also right in pointing out that India, unlike many countries, has not really had any full-blown banking crisis. This, of course, has significantly to do with the PSB dominance of the industry and the implicit government guarantee that comes along with it.

Yet, there is no doubt our banks need to raise substantial additional capital if they are to meet the credit requirements of the economy as growth and investment activity pick up. The RBI has projected the capital requirement for the banking industry for the next five years at nearly ₹500,000 crore, of which ₹415,000 crore is required by PSBs alone. Even if only a third of the capital is from equity — the rest through subordinated debt and various hybrid instruments — the Centre would have to contribute ₹90,000 crore or so to maintain its existing stakes in PSBs. Given its precarious fiscal position, the Centre obviously cannot fork out the whole amount. The PSBs will have to mobilise the balance from the equity market. Thankfully, the conditions for this are ripe now. The sooner the PSBs are allowed to go ahead, the better equipped they will be to grab the credit growth opportunities in the days ahead.

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