There has been lot of articles on the USand European banks. Let us try to analyse the domestic banks and corporates. India’s strengths is the companies they are profitable , well run and have healthy

balance-sheets. But there are pockets of indebtedness, too. A tradition of “promoters”—as individuals or families with controlling stakes are known—can lead firms to borrow rather than dilute down their masters’ stakes by issuing shares. A rabble of public-sector walking dead, from Air India to local electricity boards, bleed cash yet still get access to state-owned banks. And a boom in infrastructure projects, from roads to power stations and airports, is being paid for with debt. Some of these projects are now in trouble because of red tape and a slowing economy.

This will fuels to the concern that India has a bigger bad-debt problem than the rather stable level of banks’ official “non-performing” loans suggests. Just how big is unclear because many loans have been labelled as “restructured”. This means their terms have been softened but that they are not formally recognized as bad debts.

It will be wrong to compare India with the Spanish disease, in which evidence of rising zombie debt is cheerfully dismissed until it is too late.Spain’s regulators were complacent. At least India’s are not. The Reserve Bank of India (RBI) is on the warpath. K.C. Chakrabarty, a deputy governor, quoted : “It’s a concern. The banking system will not collapse because of this tomorrow. The system hasn’t become unstable. But if this continues for one or two years, it will become unstable.” The RBI plans to tighten the rules on restructured loans again, having loosened them in 2008 to protect India from the global crunch and given special treatment to infrastructure loans, deemed a national priority, in 2010.

In theory restructured loans are still sound; the bank has simply eased the terms to help a borrower in temporary trouble. But the rules seem to have been abused. Kingfisher Airlines is so broke it cannot pay its gorgeous cabin crew, for instance, and Air India is also manifestly in deep distress. Both seem to have been categorised merely as “restructured” borrowers for too long (some banks have now bitten the bullet). Some loans have been restructured more than once. Upon restructuring, banks are meant to recognise any fall in net present value in their books, but the losses they admit to are tiny.

There is another twist. India has superb private banks but state-controlled banks still account for three-quarters of all loans. 93% of restructured loans sit with public lenders. They tend to be in poorer shape than their private rivals, with lower capital levels, lower profitability (meaning they generate less new capital), higher officially recognised bad debts and lower provisions held against those bad debts.

Among public-sector banks the burden is loaded on smaller lenders. State Bank of India, by far the largest state outfit, has a comparatively clean balance-sheet. Exclude it from the reckoning, and 80% of the restructured loans sit with state banks that have just 50% of the Indian banking system’s Tier-1 capital.

Take Punjab National Bank. It has lots of power and airline loans. Cumulative restructured loans are 8% of the total and are roughly equal to its capital. Like many small state banks, its shares trade below their book value, indicating distress.
Working out how much banks could lose is obviously vital. Plenty of things look troubling. Almost all the loans are to big firms, presumably with political clout, increasing the likelihood of forbearance. Official bad debts recognised so far for property and infrastructure credit are implausibly low. Disclosure can be patchy.

But bankers say the rule of thumb is that only about 15% of restructured loans eventually become bad debts (and even they need not be entirely written off). A recent RBI paper assumed a worst case of 30%, in which case a far smaller fraction of the banking system—below a tenth—would be in trouble. Infrastructure loans probably make up half of restructured loans. Mr Chakrabarty sees “very little possibility that they will become non-performing…The
country has demand for infrastructure”. But he gives a warning of “some haircuts and some delays”.

So is India’s banking system in trouble? It looks likely that a big chunk of restructured loans will turn sour. The damage will be felt by state banks, particularly smaller ones. They will struggle to raise more capital because the government is cash-strapped and reluctant to pay for more equity, yet simultaneously unwilling to dilute its stakes in the banks.

Yet there will be no explosion. Indian banks rely on deposits, not fickle wholesale markets, to fund themselves. That will buy them time. And a silver lining is that India’s well-run private banks should take more market share.

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