India: "Now the Banks Have Teeth"

A new law lightens the burden of bad loans for India's state banks

On May 21, a minor miracle took place on the Bombay Stock Exchange. A rally in the stocks of India's majority state-owned banks, usually terminal laggards, sent them hurtling past the red-hot Indian tech sector in market value. The combined market cap of the 37 listed government-affiliated banks hit $13.75 billion, compared with $13.68 billion for the 147 publicly traded info-tech companies. Share prices have since fallen back, but the stock of India's 42 major banks has climbed 46% this year.

Why the bull run in beaten-down bank stocks? After all, bad loans have dogged these institutions for years. But a new law allows the banks to go after deadbeat corporate borrowers in court. The banks have been busy threatening debtors with repossession of their assets, resulting in more of them paying up. Moreover, in the past three years, the state-run banks -- which account for 70% of the sector -- have reacted to increased competition from private and foreign banks by getting serious about restructuring. Bombay-based Motilal Oswal Securities Ltd. says bank profits in the past year have gone up by an average of 35% and are expected to grow another 20% for the year ending next March.

The surprising decline in bad loans, which average 12% of all bank portfolios, has revived an industry that controls $280 billion in assets. And that has helped the overall economy. India is expected to grow 5.5% to 6% this year, after a 5% gain in 2002. "A dead sector has suddenly come to life," says Surjit S. Bhalla, an influential economist in New Delhi. "A healthy financial system will translate into at least 1.5% higher GDP growth for India in the next two years."

The law that has been the catalyst for the bad-loan cleanup passed India's Parliament last November. It allows lenders to more easily foreclose on debtors' assets or even demand a change in management. One reason the statute has been effective is that more than half of India's nonperforming loans are owed by companies that are financially sound. It's not that they can't pay -- they have simply chosen not to in the face of ineffective penalties and lax collection by banks. "Now the banks have teeth," says Rajat Rajgarhia, an analyst with Motilal Oswal.

Within weeks of the law's passage, banks saw a flood of loans once deemed unrecoverable being repaid in double time. The State Bank of India, the country's largest, with $83 billion in assets, says its nonperforming loan portfolio dropped from 5.7% of total lending in December, 2001, to 4.7% at the end of last year. The bank expects bad loans to fall to just 2% by early 2005. Union Bank in Bombay now has a whole floor and 55 employees dedicated to loan recovery, up from just a handful two years ago.

New-Delhi-based Oriental Bank of Commerce says that over the past six months its bad loans have fallen from $200 million to half that amount. The $7.5 billion-asset bank, which is 66.5% state-owned, expects to have almost none on its books by September. At the same time, OBC's outstanding loans will grow by 16% this year, to an estimated $3.3 billion. It's in such good shape that it took the unusual step of adopting U.S. accounting standards last December, only the third state-run Indian bank to do so. "Our customers are becoming more demanding, and to keep their loyalty we have to become more competitive," says OBC Chairman Bhagwan D. Narang.

Another key to the state banks' recovery is the rapid drop in interest rates. In the past four years, rates have fallen from 12% to as low as 5.9% recently. That has given banks an estimated $10 billion windfall from their holdings of high-yielding 10-year government treasuries. It has also spurred a boom in new lending. An estimated $181 billion in financing will flow through the financial system this year, a 16% increase from last year.

With cleaner balance sheets, Indian banks are enjoying their higher valuations. But the real winners are those few like OBC, State Bank of India, and Bank of Baroda, which have restructured by replacing unproductive workers with better-trained staff, expanded into new businesses such as consumer finance and housing loans, and upgraded their technology. Their aim is to more effectively compete with private outfits, such as HDFC Bank, and foreign banks, like Citibank and HSBC Holdings. "In two years, we'll be on a par with the private banks. We'll be a powerhouse," says OBC's Narang.

Global banks are still the real powerhouses. But with lighter loads of bad loans and a new competitive spirit, state-run banks are poised to give private lenders a run for their money.

By Manjeet Kripalani in Bombay

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