India's banks are staring into an abyss. Loans are souring rapidly as the economy stalls. Meanwhile, rising bond yields are making it harder for lenders to absorb credit losses from current earnings.
State Bank of India shares fell 3.4 per cent in Mumbai on August 12, after surging bad loans at the country's largest lender triggered a 14 per cent fall in its quarterly net income. But SBI is hardly alone. Gross non-performing assets at India's top 10 government-owned banks have doubled in the past two years to 1.4 trillion rupees ($24 billion) - or 4.4 per cent of the total - according to a Breakingviews analysis. Provisions that banks have already set aside will cover about half the bad loans, but clearing the remaining debris - which is swelling by the day - would wipe out one year of operating income.
Even if banks were willing to bite the bullet, they may no longer be able to. The rise in 10-year government bond yields since May will leave lenders which own a big chunk of New Delhi's IOUs with mark-to-market losses. At the same time, the Indian central bank's recent monetary-tightening efforts, designed to stem the 12 per cent slide in the rupee since the end of April, have sent the yield on three-month treasury bills soaring to 10.9 per cent, compared with 8.3 per cent on 10-year government bonds. The longer that banks face high short-term funding costs without an increase in long-term lending rates, the more their earnings will be undermined.
Nor can banks hope to bulk up their loan books in a slowing economy. That puts the ball in the government's court. Without a recapitalization of state-controlled lenders, the risk is that the clogged arteries of credit won't reopen. But New Delhi, under pressure to reduce its budget deficit, doesn't have the money for a cleanup.
Private investors can't be expected to come to the rescue, either: the BSE Banking Index has slumped by 27 per cent since May 17, outpacing an 11 per cent drop in the broader stock market. In its quest to rescue the rupee, the central bank has pushed an already-wobbly financial system closer to the edge of a precipice.
