>INDIAN BANKS : RBI’s 2Q policy – provisioning shock? not really

■ By far the biggest surprise of the RBI’s 2Q policy was the 70% NPL coverage requirement by Sep-2010; we do not believe it is all that negative – the devil is in the detail

■ While rates and CRR were left untouched, RBI’s tone was clearly hawkish; we expect rate hikes next year

■ Other measures are marginally negative – higher provisioning on real estate loans, CRR on CBLO

The eye-catcher: RBI’s credit policy announced the 70% provisioning coverage required on NPLs (non-performing loans) to be met by Sep-2010. As a consequence, bank stocks fell up to 8% post announcement given the potentially large impact on earnings and book values (see Table 1). While the measure is clearly aimed at prudency, given the risk of rising NPLs as well as potential slippages in banks’ restructured portfolios, it came as a negative surprise to the banks as well as to the market. Subsequently, at an IBA-sponsored press meeting, bank chiefs suggested that in the coming days the RBI may throw more light on the mechanics of implementation as well as possibly extending the implementation period (e.g. to Sep-2011).

What’s our take? we believe that the RBI is likely to issue clarifications shortly allowing provisions made on technically written-off loans to be included in the computation of the 70% coverage ratio (ie. those NPLs which have been fully provided for but continue to be monitored by the banks – a.k.a. ‘technical write-offs’ – as opposed to written off NPLs that have been abandoned). If this is the case, most banks are adequately protected as their coverage ratios would be at or above 70% based on our estimates of written off assets (see Table 2)

Scenario analysis: however, the question is really whether this buffer is adequate to absorb further slippages, particularly on the restructured loan book. On running a simulation of the resultant shortfall, (assuming 70% coverage required on 50% of the restructured portfolio assumed to turn into NPLs), the impact varies between 1% and 11% of FY11e book value (see Table 3)

Conclusion: RBI has clearly turned to a hawkish stance on monetary policy and we are almost certainly likely to see policy rates and the CRR (cash reserve ratio) going up next calendar year. While the RBI has turned cautious on asset quality, we believe this caution is a little overdone given the expected economic recovery starting next year.

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