Indian banks can withstand systemic stress : CRISIL

In a comprehensive review of the Indian banking system, CRISIL notes that the sector is more robust than ever before. Liquidity is adequate to support overall credit growth of 25 per cent, given normal deposit growth rates. Core profitability should remain stable in the medium term, with net profitability margins exceeding 1.5 per cent. Even though the current environment mirrors that of the mid-1990s – preceding the economic downturn of the late 1990s – the stronger fundamentals of the system reduce its vulnerability to economic stress.

High GDP growth, rapid credit expansion, and hardening interest rates, are similar to the situation prevailing in the mid-1990s. CRISIL has simulated a stress scenario applying the historic high default rates observed in the late 1990s to the current asset portfolio of banks. The stress scenario results show that the increase in non-performing loans and capital coverage of bad loans would be at acceptable levels. The simulation uses portfolio data of 23 CRISIL-rated banks representing 73 per cent of system advances. "A more diversified asset portfolio, the SARFAESI Act, stricter provisioning norms, loan write-offs over the last five years, and higher capitalisation, lend resilience to the system" says Arun Panicker, director, financial sector ratings, CRISIL.

The tight liquidity conditions prevailing in the second half of 2005-06 (refers to financial year, April 1 to March 31), have eased. A deposit growth rate of 16 per cent and a marginal reduction in the investment portfolio can support credit expansion of as much as 25 per cent in 2006-07 while still maintaining the SLR portfolio at 30 per cent for the system as a whole. However, some private banks, currently maintaining minimal excess SLRs, will need to mobilise resources more aggressively to fund credit growth.

CRISIL expects core profitability of the banking sector to remain stable despite the increase in banks' 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, as banks have successfully passed on increased borrowing costs to their customers. This has happened even when interest rates increased between 1994 and 1996.

"After a decade of improvement, asset quality in India's banking sector is superior to that of other leading Asian economies including China, Malaysia and Indonesia" says Krishnan Sitaraman, head, financial sector ratings, CRISIL. Gross non-performing assets (NPAs) declined to around 3.5 per cent of advances as on March 31, 2006, from 19.5 per cent as on March 31, 1995 aided by write-offs, recoveries, restructuring, and better health of corporate borrowers. A large retail component has aided portfolio diversification. Even in CRISIL's stress scenario simulation, weak assets (NPAs plus potentially delinquent assets) for the banking system would remain at manageable levels of 8.7 per cent of total assets.

Finally, India's banking sector benefits from stronger capitalisation. The aggregate net worth of scheduled commercial banks has improved sharply from the mid-1990s, increasing to Rs.1,417 billion as on March 31, 2005, from Rs.215 billion as on March 31, 1994. CRISIL estimates that if the new capital adequacy framework as proposed by Reserve Bank of India is implemented, capital adequacy for the system would still be comfortable at over 10 per cent, as compared to a regulatory minimum requirement of 9 per cent.