India – Loss Absorption Buffers and Gross NPAs

India – Loss Absorption Buffers and Gross NPAs

The preamble to the World Economic Report, April 2015 released by IMF projects that advanced economies will do better in the current year compared to the last year. However, the emerging markets and the low-income countries will slow down compared to the last year, reflecting weak prospects for large emerging market economies.  This is further corroborated by the recently published Global Financial Stability Report says that continued financial risk taking is shifting the locus of financial stability risks from advanced economies to emerging markets.

Where does India stand?

A significant share of debt – a whopping 40% – in India is owed by corporates and firms that are relatively constrained in repayment capacity in terms of interest coverage ratios.  The debt to equity ratio is more than three in a significant number of corporate exposures.  Debt to equity ratio that is high, indicates that the companies fund their expansion through bank borrowings, instead of raising funds from the market.  So if the economic growth slows down and interest rates go up, the health of the firm could be severely affected.

The report further goes on to say that Loss absorbing buffers have significantly deteriorated in India (Loss absorbing buffers are expressed as a percentage of risk weighted assets).  Loss absorbing buffer for India is at 7.9% of risk weighted assets against 7.8% in case of Russia, which incidentally happens to be the lowest in the world.  China is at 11.3%.  The report warns that this level of low loss absorbing capacity could destabilise the country’s banking system.

It is anybody’s guess as to how seriously the banking system is looking at the deteriorating loss absorbing capacity.  A year before, IMF had issued a similar warning of high debt (categorised as high-risk) posing a threat for country’s economic stability.

Gross non-performing loans in the Indian Banking system are reportedly at ~4 of total loans as of December 2014.  In the last four years, the Gross NPAs in India have steadily gone up from 2.4% in 2010 t0 ~4% in 2014 as per World Bank data.  Comparatively, if we look certain other countries, in Brazil it marginally dropped from 3.1% to 2.6 in the same period. In Indonesia it moved from 2.5% to 2.1%, Chile 2.7% to 2.2%, US 4.4% to 2.3%, China remained stable at 1.1% and Columbia moved from 2.9% to 3% in the same period.  There are some strong learnings for Indian banking sector from these figures.

Various reports time and again have pointed out that the tightness that is required in credit evaluation procedures keeps slipping.  Even if the lending institution may have a well documented policy for lending, the implementation on the ground suffers due to lack of clarity, mis-interpretations, people issues, inconsistencies in understanding and bureaucracy.

It is not that someone else has to tell us our own story.  That NPAs in the system are a concern, is well-known. It is high time that it is taken seriously and appropriate credit measures are brought in to reign in the increase.

Restructuring of bad loans is definitely a solution, but is must be implemented with adequate safeguards to ensure that the provisions are not used only to report better financial numbers, but also to potentially recoup the loss that would hit. The underlying portfolio health needs to be protected with the help of the restructuring measures.

For a complete review of your underwriting processes, contact SineEdge Consulting to help you overhaul the process.   We have a widespread experience in India financial consulting and to know about the projects we have executed do visit our Projects Executed page  that gives a snapshot of some of the key projects we have executed.  You can connect with us through the SineEdge website www.sineedge.com or call us through the numbers given in the website.

Photo Courtesy : Creative Commons / Flickr / GotCredit