Indian banks continue to have a strong financial risk profile backed by healthy capitalisation. The Indian banking system is relatively insulated from the factors that have led to the turmoil in the global banking industry. The recent tight liquidity in the Indian market is also qualitatively different from the global liquidity crunch, which was caused by a crisis of confidence when banks stopped lending to each other.
The strong capitalisation of Indian banks is encouraging in the current environment. As on 31 March 2008, Indian banks had an average tier I capital adequacy ratio (CAR) of above 8% as against the minimum requirement of 4.5% stipulated by the Reserve Bank of India (RBI). The tier I capital includes permanent shareholders’ equity and disclosed reserves of the Indian banks.
Most Indian banks have also raised capital over the past 12 months either in the form of equity or hybrid debt, which is expected to support growth over the medium term. The recent announcement by the government to provide the banks access to finance to help them raise their overall CAR to 12% will further strengthen the capital adequacy of the Indian banking system. In particular, the public sector banks with lower capital adequacy will be able to reach sufficient levels of capitalisation.
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This capital infusion is part of a series of measures announced by the government, in coordination with the RBI, to boost market confidence amidst turmoil in the global financial markets. It is also expected to help banks keep up the tempo of credit growth that supports economic development.
The problems of global banks were chiefly due to the exposure to sub-prime mortgage lendings and investments in complex collateralised debt obligations, whose values have sharply eroded. Internationally, banks have also been affected by the freeze in the inter-bank lending market due to confidence-related issues. On both counts, Indian banks have limited vulnerability. Indian banks’ global exposure is relatively small, with international assets at about 6% of the total assets.
Even banks with international operations have less than 11% of their total assets outside India. The reported $1 billion investment exposure of Indian banks to distressed international financial institutions is also very small. The mark-tomarket losses on this investment portfolio will, therefore, have only a limited financial impact. Another factor that goes in favour of Indian banks is that their dependence on international funding is low.
Nevertheless, Indian banks face challenges in the current economic environment, which is marked by slow gross domestic product growth, depressed capital markets and relatively high interest rates. The profitability of Indian banks is expected to remain under pressure due to the increased cost of borrowing, declining interest spreads, and lower fee-income due to the slowdown in retail lending. Profit levels are also likely to be impacted by mark-to-market provisions on investment portfolios and considerably lower profit on sale of investments compared with previous years.
While these challenges will play out over the medium term, we expect the majority of Indian banks’ ratings to remain unaffected as they continue to maintain healthy capitalisation, enjoy strong system support and benefits of government ownership in case of public sector banks.
— Roopa Kudva, Managing Director & CEO, Crisil
