Domestic Banks Face Rising Bad Debts, Funding Squeeze

 DOMESTIC BANKS may be relatively sheltered from the direct impact of the global credit turmoil, but they are fighting rising loan defaults amid a liquidity crunch that can hit profits. Leading private sector bank ICICI Bank has so far borne the brunt of investor concerns about its exposure to the financial crisis, repeatedly stressing it is solvent and deposits are safe since Lehman Brothers filed for bankruptcy protection in mid-September.
    While bad debts are expected to rise in coming months, the government has declared Indian banks to be safe. In September, the Reserve Bank of India (RBI) put out a statement saying ICICI was well capitalised as customers in some parts of the country queued up to withdraw deposits. But ICICI's shares have still lost 70% of their value so far this year as investors fear the worst.
    "If a bank faces a liquidity crunch, it is serious trouble. Some of the overseas institutions fell, not because they did not have assets, but because they did not have liquidity to fund the assets," said AK Purwar, former chairman of State Bank of India (SBI), the country's largest bank. "In India, despite the mandatory requirements, it has happened so many times before."
    On Monday, top lender SBI is expected to post a 16% profit rise on solid loan growth, while ICICI is likely to report that its earnings slipped for the second consecutive quarter. But all eyes will be on ICICI's exposure to bonds linked to Lehman and other soured credit.
    The Indian banking system is dominated by government-run banks — they account for about 70% of assets and liabilities — and all banks have to hold nearly one-third of their deposits in government bonds and as cash reserves with the central bank. Since 1969, India has not allowed a bank to collapse, merging at least two dozen troubled lenders with stronger, mostly state-run banks, according to the RBI. And Indian banks' total exposure to failed Western banks amounted to $1 billion, a fraction of their total loan book of $510 billion as of end-September, according to central bank data.
    "Indian banks do face headwinds, though it is not a worrying or dire situation now," said Ritesh Maheswari, senior director of Asia Financial Institutions Ratings at Standard & Poor's in Singapore. "But if the credit crisis is prolonged, it can have limited liquidity constraints on Indian banks and many others in the region will also face similar issues."
CREDIT EXPLOSION: Indian banks had outstanding loans of Rs 25.4 trillion ($510 billion) and total deposits of Rs 34.4 trillion ($690 billion) at end-September, according to central bank data. In the three fiscal years ended March '08, banks' lending grew at annual rates of around 30%. That has slowed to around 25%, but still remains above the central bank's preferred rate of 20% in FY09 (April/March).
    Retail loans, mortgages, credit cards, auto and consumer durable loans, which were among the fastest-growing segments, are now likely to be major risk areas as bad debts are expected to rise to 4% of advances by March '09, said rating agency Crisil, a unit of Standard & Poor's. Loans for housing and stock investments also mushroomed in recent years, helped by booming economic growth. But interest rates have risen, the stock market has plunged by more than half this year and the property market has turned down.
    Five banking analysts expect net new bad loans at Indian banks to grow on average by close to 3% in the current financial year and next, leading to higher provisions, lower profits and less money to lend. In a September report, Morgan Stanley and Oliver Wyman forecast defaults will peak over the next 12-24 months and overall provisioning costs will more than triple to Rs 75,000 crore from Rs 20,000 crore in '08.
    ICICI Bank and Axis Bank were among the most leveraged Asian banks that were exposed to a turn in the credit cycle, Morgan Stanley said in a separate report last month. "Korea, Australia and India are at top of the heap. These are countries where economic slowdown can have a big impact on asset quality and hence, earnings at banks," the report said. Analysts rank state-run banks with a strong deposit base and second-biggest private-sector bank HDFC Bank among the best suited to weather the storm.
LIQUIDITY PROBLEMS: A lack of liquidity has forced some banks to borrow at interest rates of 20% or more and frozen local money markets, prompting policy makers to unveil a slew of measures to boost lending activities. The central bank has slashed reserve requirements, cut interest rates and pumped extra cash into markets to keep credit flowing. Analysts say with the global credit markets virtually shut for local firms, the scramble for bank credit will rise, pushing up interest rates and worsen banks' asset quality.
    V Leeladhar, deputy governor at the RBI, said it was difficult to categorically give all banks a clean bill of health during such times, but he added that domestic banks were mostly well equipped to face the fallout of the global crisis. "I think nobody will be able to give you a certificate saying which banks are sound at such a time because we don't know which bank will be affected next," he said earlier this month. "Today it could be a strong bank, but tomorrow it could be bought down to its knees."
    reuters