Column: Concern or crisis?

Dec 13 2013, 09:11 IST
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SummaryThe NPL concern has been overdone to make it a crisis.

a poor 121 in the World Bank scoring model on insolvency resolution.

Restructured loans

If we consider entire reported restructured loans as NPLs from FY2007 onwards, the banking system will still continue to report healthy pre-provision operating profit (PPOP). But this time around, the magnitude is high. However, if we look at the past track record, the restructured loans have shown a recovery of about 85% in the last decade or so. Even if the assumption is 70% recovery with 10% restructured loans, the NPL increment over 2-3 years is still 3%.

Given the above background on different classes of NPLs and restructured loans, it will be necessary to run a stress test to see whether what is said above does bear fruit.

India Ratings has carried out a second round of stress test with three critical assumptions.

l CET-1 (common equity tier-1) downward adjustment: Reported CET-1 of each bank was reduced for (a) upper tier II, (b) perpetuals, (c) fully providing for pension liability, and (d) increased specific loan loss coverage ratio to 60%. The impact has been quite astounding for some of the large banks. In case of one of the largest public sector banks, the CET-1 reported stands at 9.8% but under stress case assumptions for CET-1 it reduces to 7.5% even before imposing NPLs.

l Reduced PPOP: PPOP reduced between 5-20% for each bank depending on CASA level. Lower CASA meant a 20% reduction in PPOP from March 2013 level.

l NPLs at 15%: The NPLs included approximately 10% from cyclicals and 3% infra. Additionally, two of the top 20 borrowers were taken as NPLs. The top two large borrowers may default for idiosyncratic reasons and not necessarily a sectoral downturn reason.

Results of stress test

l Nationalised banks have shown excellent risk pricing performance for cyclicals. At 10% cyclical stress, most banks report profits and are above CET-1 of 6.125%.

l Superimposing stress for single name/infrastructure most nationalised and a few private sector banks report losses for the year.

l Only five mid- to small-sized banks fail to maintain CET-1 of 6.125%.

To bring these five banks to a CET-1 of 6.125%, the bailout package costs $1.9 billion. The rest of the banks continue to remain profitable or at least remain above the minimum CET-1 of 6.125% even under such a severe stress test. This extends a substantial stability to the system and must be taken cognisance of while talking about the bank NPL situation.

Given the paltry

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