Indian banks tighten prudential norms amid growth, improved financials: Fitch

23 August 2006

Mumbai: Fitch Ratings today says that the credit profile of the Indian banking sector has improved during the last two to three years, helped by investment in risk management systems and a benign credit cycle.

The rating agency also noted that the financials of Indian banks strengthened even as the Reserve Bank of India gradually tightened the prudential norms. However, Fitch noted that despite recent progress on disclosures by Indian banks, a lot more still remains to be done in this regard.

In a report titled Indian Banks: Prudential Regulations, Fitch observes that notable changes include increased general provisions on certain retail loan categories, increased risk weight on real estate exposures, permitting banks to issue hybrid capital and shifting to a 90-day norm from 180-day for recognition of non-performing loans.

The rapid loan growth as well as the proposed capital charge for operational risk under Basel II and tightening risk weights on various loan categories has increased the banks' need for capital. With the government's holdings in many public sector banks close to the statutory minimum of 51 per cent, the RBI has allowed banks to issue perpetual debt instruments for inclusion in Tier 1 capital and Upper Tier 2 subordinated debt instruments.

Basel II capital norms will be applicable from FY07 (though the RBI has stated that it is possible that the March 2007 implementation date may be stretched slightly given the state of preparedness of various banks). Banks are required to adopt the "standardised approach" for credit risk and the "basic indicator approach" for operational risk. The final guidelines on the new capital adequacy framework under Basel II have yet to be announced.

While recognition of NPLs is based on the objective norm of 90-days overdue, RBI has encouraged banks to build additional provisions based on consistently applied accounting policies. The rapid growth in the relatively new retail loan business had raised concerns on whether the credit risk is being appropriately priced by banks, particularly since part of the portfolio is unseasoned.