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TEXT-Fitch:India restructured loan proposal would boost transparency
July 25, 2012 / 8:50 AM / in 5 years

TEXT-Fitch:India restructured loan proposal would boost transparency

(The following statement was released by the rating agency)

July 25 - The Reserve Bank of India’s (RBI) proposals for the treatment of restructured loans would increase transparency and be positive for the Indian banking system, Fitch Ratings says. The regulator has recommended increased loan-loss provisions and ultimately ending forbearance on asset classification, and instead recognizing these stressed assets as non-performing in line with internationally accepted practices.

Treating restructured loans as non-performing would help report the real credit cost of Indian banks, and encourage them to price the risk into these loans more accurately. The proposal is timely, as banks may end up restructuring more loans in two years - FY12 (ending March 2012) and FY13 - than they had in the last 10 years, due to the slowdown in economic growth and single-name concentration in the struggling aviation and state power utility sectors.

A large proportion of restructured loans are to state-owned companies in sectors undergoing structural reform. State ownership and government involvement reduces the loss expectation in these loans; however, earlier classification as non-performing may encourage banks to take a harder look at their risk profiles and step up monitoring. It could also encourage the government to provide more timely support to these entities to avoid any credit squeeze in the event these accounts become non-performing.

Applying the proposal to past performance shows higher spikes in credit costs at times of economic slowdown. Fitch’s calculations indicate that the credit cost to Indian banks would have been higher at 1.4% of loans (up from the reported 0.9% of loans) in FY10 and FY12 - two years that saw a jump in restructured loans. Correspondingly, ROA would have been lower in these years at around 0.8%, compared with the reported 1.0%.

Fitch’s through-the-cycle approach in rating Indian banks adjusts for restructured loans when evaluating asset quality. For example, the average ROA for Indian banks adjusted for restructured loans between FY07 and FY12 was closer to Fitch’s base case of 0.9% than the reported 1.05%.

The impact is more pronounced in government banks that have a larger share of stressed assets. The growing single-name and sector concentrations in some of these banks, together with funding pressures from rapid loan growth, puts pressure on the Viability Rating or standalone creditworthiness of these banks. As a result, their long-term ratings are already at - or close to - their Support Rating Floors.

The pressure on Viability Ratings may ease if the funding and asset-quality challenges are addressed. Greater transparency in restructured loans may encourage banks to try and resolve the stresses in their loan portfolios.

The proposals were made by a working group that is examining prudential guidelines on restructured loans, and the RBI has invited comments by August 21. The proposal on asset classification may not be enacted for another two years. In the meantime, the working group has recommended increasing the provision requirements on restructured loans to 5%, from the current 2%.

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