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Indian banks face rising bad debts, funding squeeze

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 was solvent and deposits were safe since Lehman Brothers filed for bankruptcy protection in mid-September.

While bad debts are expected to rise in coming months, authorities from the prime minister down have declared Indian banks to be safe.

In September, the central bank put out a statement saying ICICI was well capitalised as customers in some parts of the country queued to withdraw deposits. But ICICI's shares have still lost 70 percent 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 A.K. Purwar, a former chairman of State Bank of India, India's largest bank.

'In India, despite the mandatory requirements, it has happened so many times before.'

On Monday, top Indian lender State Bank of India is expected to post a 16 percent profit rise on solid loan growth, while ICICI is likely to report 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.

India's banking system is dominated by government-run banks -- they account for about 70 percent 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 central bank.

And Indian banks' total exposure to failed Western banks amounted to $1 billion, a fraction of their total loan book of $510 billion at 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 could 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 25.4 trillion rupees ($510 billion) and total deposits of 34.4 trillion rupees ($690 billion) at end-September, according to central bank data.

In the three fiscal years ending March 2008, banks' lending grew at annual rates of around 30 percent. That has slowed to around 25 percent, but still remains above the central bank's prefered rate of 20 percent in 2008/09 (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 percent of advances by March 2009, 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 percent 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 would peak over the next 12-24 months and overall provisioning costs would more than triple to 750 billion rupees from 200 billion rupees in 2008.

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 Bankamong the best suited to weather the storm.

LIQUIDITY PROBLEMS

A lack of liquidity has forced some banks to borrow at interest rates of 20 percent or more and frozen local money markets, prompting policy makers to unveil a slew of measures to boost lending activities.

The central 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 asset banks' asset quality.

V. Leeladhar, deputy governor at the Reserve Bank of India, said it was difficult to categorically give all banks a clean bill of health during such times, but added Indian 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.'