The health of Indian banks may be measured not just by the profits they have earned in recent years – to which treasury profits contributed a large part – but by their improving credit. In the decade since 1993, the gross non-performing loans (NPLs) of Indian banks fell from as high as one-quarter of their assets to around 7% in the year ending March 2004.
A report on Indian banks published in April by Fitch, the international rating agency, says that asset quality concerns have receded mainly through a combination of write-offs, non-performing loan recovery efforts and improved credit origination processes.
The turnaround in the Indian economy in recent years and the sharp drop in interest rates yielding healthy bank profits have contributed to the improvement. Those profits helped banks to make a sharp rise in provisions after the introduction in March last year of a stricter 90-day rule for the recognition of NPLs. Around 56.6% of banks’ gross non-performing assets (NPAs) of Rs648bn ($14.9bn) are now provided for.
Vulnerable assets
More significantly, the gross NPAs have shrunk in absolute terms in the past two years (falling by 5.6% in fiscal 2004), as a result of the increased efforts of Indian banks to clean up. The Fitch report, however, points out that assets restructured over the past three years comprise around 7% of the performing portfolio of Indian banks, and these assets could still be vulnerable.
A new law to protect creditor rights enacted in 2002 has improved the climate for lending enormously, says Cherian Verghese, chairman and managing director at Union Bank of India (UBI), a large Mumbai-based public sector bank. It has given banks the right to enforce collateral and brought errant borrowers to the negotiating table, he adds. UBI recovered Rs4.3m, or around 18%, of its NPAs last year. Oriental Bank, another public sector bank, claims to have reduced its net NPAs to zero. That law may need to be amended after a borrower, Mardia Chemicals, challenged its validity in court; the Supreme Court upheld the law but objected to a section in it.
Another important step towards disposing the existing stock of NPLs was taken when the Asset Reconstruction Company (India) Limited (Arcil) – India’s first asset reconstruction company – was set up about 18 months ago. Promoted by State Bank of India and ICICI Bank, the two largest Indian lenders, Arcil has so far acquired Rs150bn ($3.4bn) of impaired bank assets at a price of Rs35bn. CEO Rajendra Kakker says it took some effort to persuade banks to sell their impaired assets despite the clear advantage of freeing up blocked capital once those debts were off their books. “Banks were reluctant to outsource the problem and the public sector banks that own most of these assets were not ready to take hard decisions,” he says. Unlike some south-east Asian countries such as Thailand and South Korea, where a banking crisis precipitated a clean-up, there is no pressure from an imminent crisis that encourages banks to sell their distressed debt.
Debt disposal
In a move that is expected to encourage quicker debt disposal, the central bank directed banks to make a higher provision each year, starting in March this year, on secured loans that are in default for more than three years. Earlier the maximum provision a bank made on such debts was 50%; now it will rise gradually to 100% by March 2007. “Now that the holding cost on these debts is higher with each passing year, banks can be expected to take quicker decisions,” says Mihir Nanavati, head of structured products at Arcil.
The head of one public sector bank, who requested anonymity, points out that the terms offered by Arcil are not attractive enough to induce his bank to sell its debt. Arcil does not pay cash for the distressed debt but issues security receipts to them for the discounted value of the debt. This way, in the bank’s books, the bad loans are replaced by these five-year securities as ‘investments’. The securities do not carry a fixed rate of interest or repayment schedule. Payment of the principal amount and any interest to the holder of the security is subject to cash realisation from the underlying assets, says Mr Kakker. Arcil simply acts as a trustee and managing agent.
A secondary market for distressed debt securities could create the liquidity that banks seek. Qualified institutional buyers including foreign portfolio investors should be encouraged to invest but the government has yet to open the door and lay out the rules, says V Srinivasan, who heads the distressed debt division at Kotak Mahindra Bank, a private bank. Kotak offers to manage distressed assets for banks and so far it has managed assets worth about Rs11bn, most of which belonged to private banks.
“There is a fear that foreigners might buy these assets cheap and make a windfall as they did in some other Asian countries,” adds Mr Srinivasan. Mr Nanavati of Arcil points out that those fears may be overblown considering that, unlike east Asian countries where the collateral on banks’ bad assets was mainly real estate, the price of which zoomed after those economies recovered, in India the collateral is mainly in industrial assets whose price is not as volatile.
At least one foreign firm has offered to set up an asset reconstruction company in India. Actis, a private equity firm from the UK which has managed distressed debt in countries such as Indonesia, has put up a proposal to the Foreign Investment Promotion Board; the government has yet to make up its mind, say sources.
So far, the new assets being added to banks’ books appear healthy but there is some concern that banks may be ignoring credit risks in their pursuit of retail borrowers. Retail assets that account for one-fifth of total bank assets are growing furiously at more than 30% each year and non-performing loans are still low at around 2.5%. Yet they are as high as 6.3% on credit card receivables.
Credit bureau
India’s first credit bureau – set up last year by State Bank of India and HDFC, India’s largest mortgage lender, and Dun & Bradstreet – seeks to strengthen the credit appraisal and monitoring of retail loans. In the absence of any credit history of borrowers, banks are forced to create surrogates by seeking extensive details about their customers’ background, which is time-consuming and expensive, says Aditya Puri, CEO of HDFC Bank, a private bank. It has collected data on 20 million consumers from 30-odd banks so far.
The data captured on good borrowers will enable banks to offer differential pricing on their loan products, says S Santhanakrishnan, chairman of the Credit Information Bureau. The key challenges it faces though are the absence of a unique proof of identity for each customer, such as a social security number, and the unavailability of full access to customer data from public sector banks that are not networked by computers. In May, several banks including HSBC and Citigroup bought small stakes in the credit bureau.
