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    Moody’s gloom: What is ailing Indian banks?

    Publish Date: October 23, 2018

    We all know that Indian banks are not in the best of shapes at the moment.

    But Moody’s latest report rubbed salt into the wound: Indian banks are currently languishing at the bottom when compared to other BRICS nations — Brazil, Russia, China and South Africa.

    In terms of profitability, the “distinctively weak” Indian banks were at the bottom of the table, while capitalization-wise, they were second-to-bottom after Russia.

    Acknowledging Indian banks’ worrisome asset quality — in other words, the number of non-performing loans (NPLs) — Moody’s blamed the state-owned units for thrusting the entire banking industry into a funk.

    The damining report comes weeks after the Reserve Bank of India said that banks will continue to wither against the onslaught of rising bad loans.

    NPAs throttling profitability

    Banks’ stressed asset pile show no signs of lessening: from Rs 3.2 lakh crore in 2015, the number of non-performing loans has swelled to more than Rs 10.3 lakh crore as on March 31, 2018.

    While private banks do have bad loans on their books, it is mainly the more-dominant public sector units that are culpable for the current mess: more than 85% of bad loans were accounted by the latter.

    As a result, the growing stress on asset quality has impaired banks’ profitability. That’s because rising bad loans have made banks more risk-averse. They are hesitant to lend more loans now.

    Although private banks have witnessed loan growth in recent quarters, the public sector banks have become especially shy of giving advances to corporates and individuals. That’s taken a toll on the credit growth numbers. It dipped from 13.9% in 2013-24 to 8.2% in 2016-17 before rebounding to 10% in 2017-18.

    Since banks earn considerably from charging interest on loans, the public sector banks’ risk-averse strategy has impacted its earnings potential. Instead, they are largely looking to consolidate their position in the market now.

    Cowboy lending

    But what led to the surging bad debt? Between 2004 and 2008, banks — especially the government-owned ones — went on a loan-giving spree. Since they were well-stocked, banks resorted to cowboy lending. They gave advances to large corporates and individuals without having a robust loan evaluation process.

    But the honeymoon period came to a grinding halt post the 2008 global financial meltdown. Economically-austere times soon prevailed, meaning companies and individual found it tough to repay the loans, thereby saddling banks with bad debt.

    Curtailed capitalization

    According to the Moody’s report, Indian banks have the weakest capitalization with a tangible common equity ratio of 8.7%. By contrast, South African banks have a high ratio of 12.4%. This suggests that Indian banks have not been adequately capitalized.

    In October 2017, the central bank announced plans to reinfuse Rs 2.11 lakh crore into govern-ment-owned banks over the next two years so that it had enough capital to increase loan disbur-sals, earn more interest and improve its profitability in the long run.

    But the capital infusion may not be enough for government banks to meet Basel III accord — a regulatory framework that will require Indian banks to have additional capi-tal in 2019. In fact, some media reports suggest that India will need an additional infusion of Rs 2.4 lakh crore to abide by the Basel III accords.

    Moody’s have been gloomy about Indian banks’ weak capitalization levels for some time. They have previously stated how banks have limited ability to raise external capital and instead, need to rely on the government for capital infusion.

    To sum up, its a classic chicken-and-egg story. The banks poor capitalization, bad loans and profitability are all intertwined. But it must be noted that unlocking any one of these three weak spots can help turn around the banking sector.

    The good news is that the RBI has implemented a framework for resolving the bad loan problem. Analysts expect the strong audit framework to strengthen the banking structure and introduce more transparency in the entire system — factors that may help Moody’s prediction of an Indian banking sector turnaround after April 1, 2019 come true.

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