RBI concerns over rising risk from bad loans

The Reserve Bank of India has said the risks of banking sector have seen a surge for the last 6 months because of increasing bad loans. RBI has advised restricting banks’ exposure limit for single borrower and single group. It also adds that consistently high retail inflation makes it hard to dip down the rates.

The half-yearly Financial Stability Report (FSR) showed individuals and single group’s controlling stock exchanges amidst the scam in the National Spot Exchange. RBI is concerned over the bad loans in infrastructure, iron and steel, textiles, aviation and mining. On the positive side, RBI said that the delay in US tapering off its fiscal stimulus has helped India. The report said that India is likely to have a current account deficit of below 3% in FY14 and is now prepared for tapering of the fiscal stimulus in the US.

RBI's stress tests show that if bad loans double from September 2013 levels, it would be enough to wipe out over 14.3% of bank capital. The subsequent contagion effect — where losses in one entity cause other lenders to lose money — would cause an additional 26.8% erosion of capital. In all, 40.1% of the banking industry's capital would be lost if NPAs were to increase 100%, RBI said. Similarly, other stress tests show that banks would lose over 50% of their capital if interest rates were to rise by 250 basis points.

But despite the risks that high rates pose to banks and to the economic growth, RBI said that cutting interest rates was difficult because of high inflation. "Even as some moderation is expected in food inflation going forward, persistence of retail inflation remains a concern," RBI said.

The FSR — the first in governor Raghuram Rajan's regime — highlights need for new limits on how much a banks can lend to one company or one business group. RBI has pointed out that the International Monetary Fund and the World Bank had assessed India to be "materially non-compliant" vis-a-vis the Basel norms related to large exposure limits in their report on the financial sector assessment programme (FSAP). The FSAP report said, "The large exposure limit of 40 % — which can exceptionally be brought to 50 % for infrastructure exposures — for a group borrower, is significantly higher than the large exposure limits of 25% which is considered good international practice... this limit has the potential to allow the default of one particular consolidated borrower to cause a serious loss of capital in a banking company." In this context, RBI said "A review of the extant single and group borrower exposure limits would considerably enhance the stability of the banking sector."

Commenting on the NSEL crisis, the report said, "Investigations into the various malpractices at NSEL have revealed the need for comprehensively addressing the problems in commodity spot markets in India." The report also cautions against individuals or groups controlling a stock exchange. "The episode has emphasized the need for ensuring that no single shareholder or a group of shareholders is permitted to dominate the functioning of the exchange or exercise management control," the report said.

Compared to the earlier FSR released in August by former RBI governor D Subbarao, the current version is substantially positive on the external front. In August, Subbarao had said that the key challenge then was to finance the high current account deficit (4.9% in Q1FY14) in a non-disruptive manner and contain its size within sustainable levels. This time, however, RBI has said that there have been substantial improvements on the external front with exports growing much faster than imports. "From July 2013 onwards, exports have grown faster than imports. The CAD is expected to be less than 3% of GDP in FY14. The increased resilience of the Indian financial markets is evidenced by the positive reaction to the announcement of the commencement of tapering from January 2014 by the Fed," the report said.

(Courtesy: TOI)