BANKING Negative signal G. SRINIVASAN Moody's issues a raft of revisions on ratings of Indian banks, first downgrading the SBI's financial strength and now that of Syndicate Bank.

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BANKING

Negative signal

G. SRINIVASAN

Moody's issues a raft of revisions on ratings of Indian banks, first downgrading the SBI's financial strength and now that of Syndicate Bank.

AP 
 
The signage of Moody's Corporation in New York. Critics see very little substance in ratings by global agencies.

THE United States-based ratings agency Moody's recently revised Syndicate Bank's local currency deposit ratings and all its debt ratings to negative from stable. In justification, the Moody's Investors Service cryptically noted that "the revision in the rating outlook factors in the increasingly challenging operating environment for Indian banks. As Syndicate Bank has a weaker franchise than other Indian banks, its rating is more vulnerable to potential deterioration in financial strength in the current environment."

That the country's macroeconomic milieu, amid the slowdown of the economy, is none too encouraging is evident from the Reserve Bank of India's (RBI) half-yearly Financial Stability Report (FSR) released in the last week of 2011. The RBI noted tersely that all components of domestic demand (private and government, consumption and investment) had decelerated and cautioned that if gross domestic product (GDP) growth slowed down, there could be some "downstream impact on asset quality". This could be construed rather elliptically to mean that borrowers may balk at repayment citing general infirmities attendant upon a slowing economy. The year-on-year growth rate of non-performing assets (NPAs) at 30.5 per cent as at end-September 2011 has outrun the credit growth of 19.2 per cent. In fact, the latest update showing a credit offtake of 17 per cent for the period ending January 6, 2012, against the corresponding period in 2011, means that 13 policy rate hikes have wrought a deleterious impact on growth and investment.

The apex bank also did not desist from stating that additional capital would need to be raised owing to the compulsions of implementation of Basel III, even as higher provisioning requirements (due to higher slippages) and increased interest expenses already impacted on the profitability of the banking sector. Key sectors that led the trend of rising NPAs include the priority sector, retail, real estate and infrastructure. The gross NPA ratio rose from 2.3 per cent to 2.8 per cent between March and September 2011. This includes lump of loans extended to a spate of troubled sectors ranging from telecom and airlines to power, which have remained caught in either scams or policy inertia for far too long.

The bugle of caution was sounded out a couple of months ago when Moody's revised its outlook for India's banking industry from stable to negative, citing concerns of rampant inflation, monetary tightening and rapidly escalating interest rates. This downward revision arose out of an increasingly challenging operating environment for the banking system that is bound to exert adverse pressures on the system in terms of asset quality, capitalisation and profitability. With the country's money market remaining stringent on the back of rising interest costs, Moody's foresaw that Indian banks' asset quality might get worse over the next 12-18 months even as it reckoned that bank loan growth would plunge from 21 per cent in 2011 to a range of 16-18 per cent in 2012 and 2013. Moody's expected the profitability plank of the banks to weaken owing to lower interest margins as deposit rates are repriced, thanks to the liberalisation on savings deposit rates by the central bank in October last.

It is not that Moody's has suddenly woken up to the worsening operating milieu of Indian banks to issue a raft of revisions on the ratings. It began the downgrade with the rating on the State Bank of India's (SBI) financial strength on October 4, 2011. This was assailed by critics as they saw little substance in such ratings by global agencies that had not clothed themselves with any glory, having miserably failed to detect the global financial meltdown of 2008 when so many fancy financial instruments played havoc with the financial institutions in major economies of the West.

Despite such criticism of patent lapses in their own backyard, Moody's revision on the SBI, in retrospect, did not appear to be an unduly false alarm. The subsequent publication of the SBI results showed that the bank's gross NPA grew by 2 per cent between June and September 2011, against 19 per cent in the case of other public sector banks. There was also a spurt in non-performing loans aggregating to 4.19 per cent of the total advances, with loans amounting to Rs.8,000 crore slipping from the standard category (asset on which there is no default) to the substandard category (marked by defaults). What is causing flutters is that the SBI's core capital, or Tier-I capital (in terms of capital adequacy norms as set by the central bankers' central bank, the Basel-based Bank for International Settlements), had slipped to 7.4 per cent in the quarter ending September 2011 against the mandated 8 per cent.

PAUL NORONHA 
 
THE STATE BANK of India's headquarters in Mumbai

However, Minister of State for Finance Namo Narain Meena, while responding to a query in the Rajya Sabha on November 29, maintained that the "Indian banking sector is in sound financial health and Moody's ratings would not have a long-lasting effect on the banking sector in India". Though the domestic banking industry has not been jolted because of the constant revisions by overseas ratings agencies on Indian banking, the fact remains that the economic slowdown and the lack of appetite for investment either to start a new one or expand the existing ones mainly due to the prohibitively high cost of credit by financial institutions might pose problems in terms of asset quality and risk-taking spurs by the banks in particular. Industry analysts too contend that given the sort of stickiness of the system as a whole due to assets and liabilities mismatch, concerns over the quality of loans and the general economic slowdown, the banking industry will be on a sliding board if it does not get its act together.

The year 2011 proved to be a year of hardships in terms of persistent inflation and a year when the Sensex fell by 25 per cent. The rupee declined by a staggering 16 per cent, rendering it the worst performing major Asian currency, besides making import-dependent energy cost expensive and pushing the price of other imported essential inputs. It is small wonder then that the investors, particularly institutional investors from abroad, were actively pulling their funds from India. Net outflows were $380 million in 2011, after rising to a hefty $29 billion in 2010.

Given the reality that the economy's return to a consistently high growth path would take a couple of years, the banking industry has a greater responsibility in the recovery process of the real sectors of the economy in keeping the credit spigot ajar. But it is precisely when the need for greater capital infusion is imperative that the banks have been directed by the authorities to go for financial inclusion for lending to many welfare programmes.

Against this development, the RBI has released draft guidelines on the proposed implementation of global norms of capital adequacy (Basel-III), requiring banks to go in for capital infusion during the next five years. How far the domestic banking industry will be able to meet the challenges of taking a proactive part in the recovery to high growth while simultaneously beefing up its capital base to meet the international norms of capital adequacy ratio will determine not only its fortunes but also its ability to survive and thrive.

The moot issue is whether the government should allow public sector banks the requisite operational autonomy to meet both ends. Will the banks be able to face price risks in a prudent fashion given their reluctance to lend in the light of the stickiness of the existing loans to various sectors is a difficult issue but one that must be addressed squarely for the long-term viability of the banks and to underpin growth impulses of the real sectors of the economy.