RBI's rate cut to arrest worsening asset quality of banks

Has the looming risk of banking sector's deteriorating asset quality been one of the considerations for reducing policy rates at a time when the inflation danger still persists?

The answer is clearly 'yes' as for the first time the Reserve Bank of India (RBI) Governor D. Subbarao has made a passing reference on the risk of deteriorating asset quality.

While summarising macroeconomic concerns in his customary policy note, the RBI Governor has said the inflation remains sticky and above the tolerance level, even as growth has slowed. "These trends are occurring in a situation in which concerns over the fiscal deficit, the current account deficit and deteriorating asset quality loom large."

Not just are non-performing assets (NPAs) in the banking sector on the rise, the demand for corporate debt restructuring (CDR), which reflects stress on the system, is a flood. Between April and December 2011, the CDR cell has approved 34 cases with Rs 31,600 crore debt. "Out the total CDR cases, the slippage is only about 15-20 per cent and 80 per cent are proved to be good assets," says Anand Sinha, deputy Governor of RBI. 

With the RBI's successive rate hikes, economic growth has already slipped from 8.4 per cent to 6.9 per cent and it was only a matter of time for the banks to come under pressure. Many companies in the highly leveraged sectors like infrastructure (engineering and construction), telecom, real estate, aviation, iron and steel etc. are already on the verge of default.

The impact of higher interest rate is gradually spreading to banks, eroding their capital bases as they have to provide for higher NPA provisioning. In fact, many banks with retail loans have been forced to extend the tenure of the home loans to as high as 65-70 years, which is an alarming trend.  

Clearly, the rate hikes beyond a point impact retail as well as corporate borrowers as the slowing economy and higher inflation impacts household budgets and cash flows of the corporate sector.

Today, the gross NPAs of the banking sector are reaching close to Rs 130,000 crore (as of December last year). The size of NPAs was Rs 94,084 crore at the end of 2010/11. According to an estimate, the gross NPAs of the state owned banks in the first three quarters of 2011/12 have increased to 2.4 per cent from 1.9 per cent in March 2011, while that of the State Bank of India group of banks have increased sharply to 4.3 per cent from three per cent.

In a bankers' meeting in Mumbai on Tuesday, the RBI Governor said the banks' asset quality continues to be under pressure and they are keeping strict vigil. In February, the two deputy governors - CK Chakrabarty and Anand Sinha - also met close to a dozen bank chairmen to assess the NPA situation. "The banks told us they are more sensitive to the need to manage NPAs than in the past," Subbarao said on Tuesday.

So, finally, there is a relief for bankers.