Indian banking system immune from '90s crisis: CRISIL
02 Aug 2006
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The Indian banking system is better positioned today than ever before in terms of its business and financial health, notes a new CRISIL study. Says Arun Panicker, director, financial sector ratings at CRISIL, "The past few years have seen a continuous improvement in the key indicators of the banks' health, such as asset quality and capital adequacy." This is in alignment with the global banking trends: the performance of the banking sector has improved globally over the past few years.
According to Krishnan Sitaraman, head, financial sector ratings, "CRISIL has ratings outstanding on the debt instruments of 34 scheduled commercial banks; these banks account for 80 per cent of the Indian banking industry's assets. The outlooks, wherever assigned, are stable, on the expectation that the banks' credit will not change materially over the medium term." For the 21 rated public sector banks, CRISIL's ratings reflect the benefits of majority ownership by the government of India, which are expected to continue, and the banks' strong resource profiles.
CRISIL's recent banking sector analyses illustrate these conclusions through the following five commentaries:
- Impact of similarities with mid-90s manageable for banks: There are numerous superficial similarities between the mid-1990s and the mid-2000s, including money supply growth, credit growth, economic growth, industrial growth, and interest rate trends. However, CRISIL sees the underlying indicators pointing towards a substantial improvement in the current overall health of the banking system vis-à-vis the 1990s. Asset quality has improved significantly, with gross NPAs at less than 4 per cent of advances as on March 31, 2006, compared to 19.5 per cent as on March 31, 1995.
Similarly, the capitalisation levels of the scheduled commercial banks has also improved sharply from the mid-1990s, with the aggregate net worth increasing to Rs1,417 billion as on March 31, 2005, from Rs215 billion as on March 31, 1994, leaving them adequately capitalised on a systemic basis even for a stress scenario. Thus, although the deteriorating asset quality in the late 1990s had a severe impact on the banks' balance sheets, CRISIL believes that such a situation is unlikely to recur today. - Banking sector liquidity manageable at systemic level: CRISIL's analysis reveals that, despite high credit growth rates, systemic liquidity is expected to be manageable in the medium term. In 2005-06 (refers to financial year, April 1 to March 31), the credit extended by the banking sector grew at a rapid 32 per cent, after a significant 26 per cent credit growth in 2004-05. The deposit growth of 15 per cent in 2005-06 was not sufficient to cover this increase. While bank deposits have not been losing out significantly to other sources of savings, the magnitude of credit growth has forced the banks to look to other sources of funds as well.
The gap between deposit growth and credit growth also resulted in some tightness in liquidity in the banking sector during the second half of 2005-06; banks have managed this tightness by selling off investments, and increasing bulk deposits. CRISIL believes that this tightness was a temporary phenomenon, and the aggregate liquidity situation in the banking sector is now manageable.
CRISIL's analysis also reveals that a bank deposit growth of 16 per cent in 2006-07 will be sufficient from a systemic perspective to comfortably sustain credit growth of even 25 per cent, given the current structure of banks' balance sheets. Nevertheless, on a case-specific basis, there are banks that have low levels of excess statutory liquidity ratio (SLR) investments; in the absence of corresponding deposit growth, such banks would need bulk borrowings to meet the credit expansion.
- Banking sector asset quality - better than ever before: After a decade of improvement, asset quality in India's banking sector is superior to that of other leading Asian economies such as China, Malaysia and Indonesia. Three years ago, Indian banks were using treasury gains to provide for non-performing assets (NPAs) or write them off; today, however, recoveries are the single most significant route for NPA reduction. CRISIL's simulation of a stressed economic scenario reveals that, even if asset quality were to deteriorate significantly today, the impact on the banking sector would be manageable. This is primarily because of improved capital adequacy, greater diversity in asset portfolio, stronger credit profile of borrowers, and increased risk awareness among banks.
- Banking system adequately capitalised even under Basel-II Framework: CRISIL believes that the incremental capital requirement for the banking sector on the implementation of Basel II norms, and the demands from unprovided-for 'weak assets' are manageable on a systemic basis; 'weak assets' indicate assets that are of an inherently poor credit profile (including speculative exposures, current NPAs and delinquent accounts in case of retail portfolios).
Banks have raised around Rs.150 billion of capital in 2005-06 to finance the high credit growth and ready themselves for Basel II norms. The flexibility given to banks to raise different forms of capital, permitting the issue of hybrid capital, will help them maintain adequate capital levels on a systemic basis.
- Northbound rates not to hit banks' core profitability: CRISIL expects the core profitability of the banking sector to remain stable despite the increase in cost of funds. The banking sector has had a largely stable interest spread, between 2.6 and 3.2 per cent, for more than ten years (even in the increasing interest rate scenario in 1994-96). In 2005-06, there was a decline in the banking sector's core profitability (which excludes non-core aspects such as profits and losses on the investment book).
This was reflected in a lower Net Profitability Margin {NPM which is defined as (Yield on funds deployed) - (Average borrowing costs) - (Operating expense ratio) + (Fee income levels)}. CRISIL believes the decline in profitability was