Indian banks could see a significant erosion in capital and profits over the next one year as bad loans pile up, making it imperative to raise provisions, stress tests by the Reserve Bank of India showed.
Banks could see their capital adequacy ratio falling by 100 bps to 11.5% by March 2016 as gross non-performing assets (GNPA) rise to 4.8% by September and drive up provisions, said RBI in the Financial Stability Report (FSR).
“Current deterioration in the asset quality of SCBs may continue for few more quarters and PSBs may have to bolster their provisions for credit risk from present levels, to meet the ‘expected losses’ if macroeconomic environment deteriorates further under assumed stress scenario,” said the central bank.
While the banking stability indicator has improved marginally, concerns remain due to the weak asset quality and sluggish profits of banks, the RBI said. “Deterioration in the asset quality, if any, could adversely affect the health of the banking system,” RBI added.
Stress tests showed that 4.8% of banks’ loans would have turned bad over the next six months from 4.6% gross non-performing assets ratio (GNPA) as of March end. Within the banking system, public sector lenders may see a sharp rise in bad loans to about 5.7% of advances by March 2016, the report said. Infrastructure continues to remain the biggest contributor of stressed assets and within this, power and transport are the concern areas, the report said.
As a result of bad loans, banks will have to set aside more provisions which could bring down the capital adequacy ratio to 12% by September and 11.5% by March 2016, the report said. The ratio for public sector banks could fall even lower to 10.2% by March 2016. Under Basel-III norms, banks have to maintain a minimum capital adequacy ratio of 9% with Tier-I capital of 7%. Stress tests simulated three scenarios using different levels of deterioration of macroeconomic indicators such as growth, inflation and fiscal deficit. The baseline scenario assumes growth at 7.6%, retail inflation at 5.3% and a fiscal deficit at 3.9% of the gross domestic product. Extreme stress would mean that growth plummets to 3.6%, inflation rises to 9.7% and fiscal deficit rises to 6.3%.
Another set of stress tests to gauge credit risk and concentration risk among banks showed that under extreme stress, which assumes a GNPA ratio of 10.5%, the capital adequacy ratio declines to 9.9% for banks. The report warned that a rise of GNPA to 7.6% wherein 30% of restructured assets turn bad could wipe out the profits of all banks.
