New norms to boost foreign bank lending

FALLOUT OF PROPOSED PRIORITY SECTOR LENDING GUIDELINES

Barclays Bank's total lending in India is just over Rs 4 crore, but its off-balance sheet liabilities are over Rs 2,50,000 crore. If the RBI goes ahead and implements its revised priority sector lending guidelines from April 1, 2007, then the British bank will have to lend over Rs 1,200 crore to priority sectors.

That's because the draft guidelines propose to use either the net bank credit or credit equivalent of off-balance sheet exposure as the base for calculating bank's priority sector lending obligations.

Barclays Bank is not much into lending activities, but its investment banking and derivatives business has seen a sharp rise over the last couple of years as Indian corporates went on a fund raising spree.

Foreign banks are required to lend 32 per cent of net bank credit or credit equivalent of off-balance sheet (OBS) exposure to priority sectors such as agriculture, small scale industries, small business/service enterprises, micro credit, education loans and housing loans.

For Indian banks, the priority sector obligation is 40 per cent of credit or credit equivalent, whichever is higher.

Barclays Bank's off-balance sheet exposures jumped to Rs 2,60,241 crore at the end of March 31, 2006 from Rs 1,45,559 crore a year earlier, while its advances book grew from Rs 2.42 crore to Rs 4.33 crore.

Barclay's priority sector obligations will rise by over Rs 1,200 crore taking into account the bank's OBS as on March 31, 2006 and the credit equivalent is taken at 1.5 per cent of the total OBS.

The average credit equivalent of OBS for the entire banking system about 1.9 per cent of the total contingent liabilities.

Calyon Bank's OBS exposure currently is at a level where it would not have to increase its lending to priority sectors.

But if the credit equivalent is around or higher than the banking sector level of 1.9 per cent, the bank would have to lend at least an additional Rs 300 crore more to the priority sectors.

The number of banks which are actively involved in these activities in India are only 15, most of which are foreign banks.

The combined share of these 15 banks in total off-balance sheet exposures steadily increased from 73.8 per cent in March 2002 to 82.3 per cent in March 2006.

The growth in OBS exposures in India has been fuelled by the phenomenal increase in derivatives segment.

Between end-March 2002 and end-March 2006, contingent liabilities of the banking system recorded an annual compound growth rate of 23.6 per cent, while contracts and derivatives increased at an annual compound growth rate of 55.5 per cent.

Credit equivalent is the potential cost replacing the contracts' expected net cash flows in the event of default by the counter-party. At the system's level, total credit equivalent of outstanding derivatives constituted 1.9 per cent of notional principal at end-March 2006.

RBI feels the proliferation of derivatives exposures inevitably poses a challenge to financial stability on account of the immense downside risks associated with them.

One important source of vulnerability in the Indian derivatives market relates to high concentration risk since the number of counter-parties (both banks and corporates) are limited.

The concentration of activity and knowledge among a small number of players raises the potential risk of systemic market crisis owing to default by a few counter-parties.