>BANKING SECTOR (KARVY)

ASSET QUALITY TO THE FORE

Asset quality in Indian banking is rearing its ugly head but is not immediately discernible on account of regulatory forbearance that has allowed banks to classify poor quality loans as restructured standard loans with minimal provisioning requirements. Such a practice, sadly, results in severe under-reporting of non-performing loans and inflation of past and future net profits. Our study reveals that the government banks' poor quality loans (net nonperforming loans and restructured standard loans) for FY2009 constitutes around 48% of the it’s net worth as compared with nearly 18% of net worth in FY2008 and the segment is therefore in need of equity recapitalization
which the government can ill-afford on account of fiscal constraints.

Non-performing assets (NPA) disclosure does not accurately reveal extent of the problem: In our sample of 26 (23 government and 3 private) banks; gross NPAs in FY2009 increased by 18% to Rs 558bn while net NPAs rose by 23% to Rs 261bn. As a percentage of loans, the data shows an improvement with gross NPAs declining to 2.2% from 2.3% in FY2008 while net NPAs falling to 1% from 1.1% in the same time period. As a percentage of net worth, net NPAs rose marginally from 10.2% in FY2008 to 10.8% in FY2009. The all-important coverage ratio reported a decline to 53.3% in FY2009 from 55.3% in FY2008. On the reported NPAs there appears to be no major cause of concern but that is because a significant amount of poor quality loans were reported as restructured standard loans instead of NPAs.

Significant increase in restructured standard loans: While NPAs increased less alarmingly, the huge increase in restructured standard loans is an ominous sign that all is not well in Indian banking. In our opinion, restructured standard loans have to be classified as non-performing as we believe that without restructuring the terms of the loans, such loans would have had to be classified as NPA. Total restructured standard loans in our sample of 26 banks increased 4.2x over FY2008 to Rs650bn. which was more than the gross NPAs of Rs558bn. Within restructured standard loans, the bulk of the increase is coming from non-corporate debt restructuring (CDR) standard loans which implies that the broad underlying loans in the banking sector from small & medium enterprises (SME), retail and agriculture are deteriorating. The huge increase in restructured
standard loans is a more accurate depiction of the deterioration in asset quality in FY2009. As a result, gross impaired loans (gross NPAs plus restructured standard loans) increased by 93% in FY2009 to Rs1,208bn while net impaired loans (net loans plus restructured standard loans) rose by 149% to Rs910bn.

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