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The Reserve Bank of India’s latest Financial Stability Report reaffirms a trend that has been playing out for more than a year, that asset quality at banks is worsening. While gross NPAs in the system were 4.2% at the end of September 2013, stressed assets had crossed 10%; for public sector banks, this number was even higher at 12.3% of total advances. The deteriorating asset quality, as the central bank has observed, makes banks more vulnerable. The Banking Stability Index, which measures the expected number of banks that could become distressed given at least one bank becomes distressed, shows that risks to the banking sector have risen since June. There’s no need to panic because even if slippages are high, which is what happens in periods of weak economic growth, there is enough capital to cushion the losses.
RBI is hoping to stem the tide of rising NPAs by putting in place a system that is designed to help banks spot the rotten apples early in the day and, more important, deal with them doubly fast. RBI is even willing to go the extra mile to incentivise lenders that are able to get on top of the problem quickly. RBI also realises that the exposure limits specified for customers—single borrowers and groups—need to be re-looked. As of now, banks can lend as much as 15% of their capital funds to a single borrower and as much as 40% to a group; in some special cases these limits can be stretched to 25% and 55% respectively. That these limits are way higher than those prevalent internationally does not come as a surprise; study by the IMF and World Bank found India was “materially non-compliant” with the large exposure limits prescribed in the Basel guidelines.
Commercial banks too needed to have invested more time and expertise while appraising projects. If the share of stressed infrastructure loans is 30.3% of the total stressed portfolio, some of the blame must lie with the lenders. They simply haven’t taken enough care to assess the viability of the projects and, as it turns out, most infrastructure players today have hugely leveraged balance sheets with cash flows that can barely service the debt. As a result, more loans are being restructured and in some instances, like with Lanco Infra, the consortium is also committing additional money. While banks clearly need to acquire better appraisal skills and, more important,