NPAs soar, mutual funds/insurance funding banks rises
Given how sharply the economy has slowed, it’s not surprising the quality of banks’ balance sheets is worsening. RBI says as much in its latest Financial Stability Report (FSR), citing a stress test that reveals a deterioration in their capital position. Indeed, banks accumulated bad assets at a faster pace of nearly 44% last year while they grew their loan books by just 16.3%. The numbers could look uglier. For instance, should the GDP grow at a low 5.6%—not impossible despite government initiatives—gross NPAs could quickly rise to 3.9% by March 2013, 100 basis points more than they were in March 2012. And that’s only if the thumb rule that RBI works on—that typically just 15% of restructured assets slip—holds true. Going by the sharp jump in referrals to the CDR cell—estimated at close to R20,000 crore for the three months to June 2012—not only could the restructured portfolios of banks see a big jump, a weakening economy could see more of these loans turning bad. Another stress test, of NPAs rising by 100% (as compared to 44% in FY12), sees NPAs rising to 5.8% with 5 banks (accounting for 6.7% of all banking assets) seeing their CRAR fall below 9%.
What is more scary is that many of the country’s bigger banks are part of the same consortia—Kingfisher and Air India for instance. Which is probably why RBI has highlighted the systemic risk posed by this increased inter-connectedness; the regulator reckons the maximum possible loss to the banking system due to the failure of the ‘most connected’ bank has risen from 12% of the capital of the banking system to over 16% over the four quarters of 2011. Probably for the first time, the central bank also draws attention to the risks posed by insurance firms and mutual funds invested heavily in banks—by March last year, nearly 27% of the entire intra-financial system borrowings by banks was from insurance companies while another 37% was from mutual funds, and this is higher in the case of private banks. Apart from causing a systemic stress, there are also mismatches since the bulk of the borrowing by banks from mutual funds (81%) consists of short term funds. And, to make things worse, LIC is invested in the equity of PSU banks.
While talking of the increased global risk, especially if European banks start withdrawing capital from countries like India—their claims on India are $146 billion, half of which are from UK banks—RBI doesn’t think this poses a great problem as the share in banking assets is not that high, though the impact on areas like trade finance could be high. What it means for India’s forex reserves, however, is probably the subject of some other report.