Once criticised as inhibitory, India's strict regulatory norms have protected local banks from the global financial tsunami.
The global financial turmoil has hit a number of financial institutions overseas, resulting in write-downs, bailouts and bankruptcies. In contrast, the Indian financial system has largely escaped unscathed, thanks to a stringent regulatory framework, which was considered stifling in times of upturn.
Not that the Indian banking system has not had its share of worries during the recent crisis. Four large Indian banks with significant foreign presence had to make provisions for potential losses due to their exposure to overseas financial institutions. These are: ICICI Bank (international assets accounts for 22 per cent of total assets), State Bank of India (7 per cent), Bank of India (18 per cent) and Bank of Baroda (19 per cent).
But by and large, the Indian banking system has been left untouched by the unfolding crisis, not only due to regulatory restrictions, but also because of their limited exposure to US-mortgage backed securities. The central bank’s stranglehold has also ensured that the Indian financial system has a leverage of 13:1 – small in comparison with the US investment banks’ leverage of 30:1.
Another factor that provides succour during such times is the dominant role that government-owned banks play in the Indian banking sector. These banks hold financial assets worth 77.2 per cent. Moreover, all banks, irrespective of ownership, need to invest over 32 per cent of their deposits with RBI or invest in sovereign bonds.
Reserve requirements set by RBI are among the highest in the world. This ensures that RBI and the banking system have enough muscle to support the economy when there is a slowdown or liquidity crisis. Effectively, this also means that banks have limited credit risk and the balance sheets have significant liquidity. Consider these facts: Over 90 per cent of borrowing with the banks is in the form of deposits. Almost 75 per cent of risk assets are in the form of loans rather than bonds or securities. The industrial loan book is fairly diversified across sectors – the top five sectors account for 58 per cent of industrial loans. The consumer exposure, including mortgages, is less than 25 per cent of the system’s loan book.
In the case of bank failures, the Indian regulator guarantees a payment of up to Rs 100,000 to each depositor. This guarantee extends to over 95 per cent of depositors. Also, over 50 per cent of deposits by value are protected.
| TOP 5 BANKS | ||||||
| Networth (Rs crore) | CAR (%) | |||||
| 2006 | 2007 | 2008 | 2006 | 2007 | 2008* | |
| State Bank of India | 27,644.09 | 31,298.56 | 49,032.66 | 11.88 | 12.34 | 12.64 |
| ICICI Bank | 22,555.99 | 24,663.26 | 46,820.21 | 13.35 | 11.69 | 13.97 |
| Punjab National Bank | 9,376.36 | 10,435.46 | 12,318.35 | 11.95 | 12.29 | 12.96 |
| HDFC Bank | 5,299.60 | 6,433.15 | 11,497.23 | 11.41 | 13.08 | 13.60 |
| Bank of Baroda | 7,844.43 | 8,649.94 | 11,043.93 | 13.65 | 11.80 | 12.91 |
| *Based on Basel II | ||||||
| TOP 5 BANKS | ||||||
| Net NPA to Net Adv (%) | Unsecured loan to Advances (%) | |||||
| 2006 | 2007 | 2008 | 2006 | 2007 | 2008 | |
| State Bank of India | 1.88 | 1.56 | 1.78 | 23.24 | 24.39 | 26.94 |
| ICICI Bank | 0.72 | 1.02 | 1.55 | 16.99 | 20.23 | 23.09 |
| Punjab National Bank | 0.29 | 0.76 | 0.64 | 14.91 | 14.62 | 16.82 |
| HDFC Bank | 0.44 | 0.43 | 0.47 | 30.84 | 28.92 | 29.97 |
| Bank of Baroda | 0.87 | 0.60 | 0.47 | 19.39 | 22.47 | 26.26 |
Indian banks have stronger balance sheets compared to the past, as net non-performing loans (NPL) of Indian banks have fallen consistently over the last five years. In fact, subsequent falls in government bond yields have translated into sufficient gains for banks, helping them clean up their books.
The best way of judging a bank’s health is to look at some critical parameters such as capital adequacy ratio (CAR), asset quality and earnings, which define banks’ ability to pay off their service depositors in times of crisis. On all these parameters, Indian banks meet the accepted norms.
State Bank of India has the highest net worth in capital and reserves among all Indian banks, followed by ICICI Bank. Each of the two has about four times the net worth of the third biggest bank, Punjab National Bank, in this category.
Most Indian banks have non-performing assets (NPA) amounting to less than one per cent. The average NPA of all banks operating in India (including foreign banks) is around one per cent. The reduction in NPAs has been primarily driven by higher write-offs earlier and higher recoveries done very recently. The gross and net NPA ratios have improved from the 1994 levels of 19.5 per cent and 10.7 per cent to the current levels of 2.4 per cent and 1.1 per cent, respectively.
The marked improvement in asset quality is a result of tightened NPL recognition norms (from 180 days to 90 days) and provisioning norms having come into force from March 31, 2004. The incremental slippage ratio has also trended down from 5.3 per cent in 2001-02 to the current level of 1.8 per cent.
Among the big Indian banks, ICICI Bank has the highest capital adequacy ratio of 13.97 per cent against the mandated 9 per cent. Four banks, all of which are smaller than ICICI, have higher CAR than ICICI Bank. Overall, 28 Indian banks have a CAR of more than 12 per cent each. Not even a single bank has a CAR of less than 9 per cent. Under the norms, banks need capital worth Rs 9 for every unit of asset worth Rs 100.
Going by FY08 numbers, none of the Indian banks, big or small, can fail.However, the current fiscal, beginning April, has brought with it some troubling signs of an economic slowdown. The rapid credit expansion in recent years has resulted in a jump in NPAs.
At the same time, a disproportionate rise in the unsecured books combined with the growing lending is a cause for concern. This, in an economic downturn, could mean a higher probability of default, as well as a lower probability of recovery, if the loans get converted into NPAs.
Over the past six years, the ratio of unsecured loans to total loans has doubled from 10.8 per cent to that of 21.9 per cent. This means that unsecured loans have compounded at a massive 49 per cent during these years. For individual private sector banks, the ratio has increased from 6.7 per cent in 2001-02 to 23.4 per cent in 2007-08.
The top three banks in private sector have more than 15 per cent of their portfolios in unsecured loans and advances.
