Where will the banks rest with these debts?

Mon, 10 Aug Pre-Open

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What happens when companies funded by huge bank loans come on the verge of defaulting them?

By no doubt, the banks funding them are left to bear this burden. However, the situation arises when banks themselves lend indiscriminately to debt-laden firms. In the end they are left with no choice other than opting to a haircut in order to ensure that the debt can be serviced. The same can be said for Indian state-run leaders.

As per an article in Livemint, Indian banks may need to take loan writeoffs of more than Rs 1 trillion. This has come out as a result of their exposure to high leveraged large corporate houses. Many of these companies are from stressed sectors such as power, infrastructure and steel. The power and other infrastructure sectors account for 50% of this exposure. The balance is covered up by steel, aviation, ship-building and textile sectors. This has brought the overall bad loans and restructured assets to over 11.5% of the system as of end March 2015. Of the abovementioned Rs 1 trillion, about Rs 930 bn is required by the public sector banks (PSBs) alone. This is equivalent to an equity write-down of about 1.7% of their risk weighted assets.

The estimated amount is over and above the Basel-III capital requirements as stated by Indian Ratings. According to a report released by India Ratings & Research (Ind-Ra), the companies won't be able to repay their loans even if their projects are put back on track. From these 30 companies are with individual debt of Rs 50 bn, aggregating 7% to 8% of the overall bank credit. Banks will further need an additional core capital of Rs 2.5 trillion under Basel-III guidelines.

The government in the meanwhile has asked PSU banks to raise Rs 1.10 trillion from markets to meet more than half of their capital requirement of Rs 1.80 trillion.

The most affected are the mid-sized state run banks with low net interest margins and weak capitalization. Hopes are set on 5/25 refinancing schemes where banks can extend loan repayments for a period of up to 25 years. This can solve short-term liquidity problems. However, writing off the loans will not help banks keep up their credit growth on a sustained basis.

So the recapitalization of PSU banks is only a short term reprieve. And the real problems are far from being resolved. Investors should take into account the sustainability of credit growth and asset quality instead of investing in banks looking forward to writing off bad loans with newly acquired funds.