India Central Bank Sees Sharp Rise in Bank Risk on Bad Loans

What's Next for Rajan and the RBI?
  • Profitability at lenders falls to lowest level since 1999
  • Outgoing RBI Governor Rajan had campaigned against bad debt

Risks to India’s banking industry have “sharply increased” since September as surging bad loans drag lenders’ profitability to the lowest since at least 1999, according to the Reserve Bank of India.

Banks’ return on assets fell to 0.4 percent at the end of March from 0.8 percent a year earlier, according to the central bank’s Financial Stability Report released Tuesday. The industry’s gross bad-loan ratio jumped to a 13-year high of 7.6 percent, following a six-month RBI audit of banks’ bad-debt disclosures. Under a “baseline stress scenario,” that ratio may rise to 8.5 percent by next March, the deadline set by RBI Governor Raghuram Rajan for banks to clean up soured credit, the report showed.

“Given the higher level of balance-sheet impairment, banks may remain risk averse for some more time as their focus would be on strengthening” those balance sheets, according to the report.

The new figures underscore a key challenge for the central bank’s next governor when Rajan steps down in September after waging a campaign through his three-year leadership against banks’ hidden stressed loans and inadequate provisioning for soured credit. Rajan stunned the nation earlier this month by announcing that he won’t seek a second term in the job.

Stress Test

The ratio of gross bad loans reported for March was the highest since the same month in 2003 and compares with 4.6 percent a year earlier. The RBI study, which is released every six months, measures risks to India’s banking system using a so-called banking stability map, which tracks factors including profitability, asset quality and liquidity. 

“Risks to the banking sector have sharply increased since the publication of the previous” stability report in December, the RBI said. “Stability conditions in the banking sector, which started deteriorating in mid-2010, have now worsened significantly.”

Stressed assets, which comprise of soured debt and restructured loans, rose to 11.5 percent of outstanding lending by March from 11.1 percent the previous year, according to the report.

In Mumbai on Wednesday, shares of State Bank of India gained 0.8 percent, while ICICI Bank Ltd. rose 1 percent as of 10:22 a.m. local time. The S&P BSE Bankex, a gauge of ten Indian lenders, advanced 0.5 percent, paring its drop in the past year to 3.4 percent.

Lower demand for goods and services in the country has eroded the ability of companies to repay debt, leading to surging soured loans and weaker bank profitability. More recently, comments accompanying the March quarter results from some of the country’s largest lenders including ICICI Bank have fueled concerns that dud loans will keep piling up.

Other steps taken by the RBI under Rajan in its fight against bad loans include doing away with almost all exemptions allowing banks to classify stressed assets as standard loans, and the so-called strategic debt restructuring scheme, which allows lenders to convert debt owed by companies into equity.

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