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Why NPAs matter

Getting a loan is more difficult now because rising bad debts have made banks cautious about lending. But borrowers with a clean credit profile can get good deals.

Tanvi Varma/Money Today | Print Edition: February 19, 2009

When banks across the world came crashing down, we were told that the Indian banks were largely insulated from the global crisis. Even the campaign to malign the largest Indian private bank came to nothing. And so customers believed that all was well. However, it looks like that period of complacency is ending. "The results declared by banks show an increased strain on asset quality," says Amitabh Chakraborty, president (equity), Religare Capital Markets. The deterioration in asset quality can be measured by the non-performing assets (NPAs) in a bank's books.

How Banks Tackle NPAs
Bank Strategies
Impact On Consumer
Stricter recovery norms for unsecured loansDowngrading credit limits and differential rates for defaulters. Borrowers with good credit history to get better rates, offers.
Reducing exposure to unsecured loansStringent scrutiny of documents, disclosure of purpose of loan, cross-checking history with CIBIL. Difficult to get loans via agents.
Restructuring of loans to avoid classification as NPAs in booksEasier repayment schedules, especially if collateral is provided. Loan tenure extended and EMIs reduced to suit borrower.
Increase in margins required for secured loansRatio of loan reduced from 90% of asset value to about 75%. EMI to income ratio reduced from 60% earlier to almost 50% now.
Reducing exposure to export sectors to avoid risk of defaultTightening of credit appraisals. Decrease in credit limits, higher interest rates and increase in margins on loans.
Increased focus on low-cost depositsLaunch of value-added savings and current account products to mobilise current and savings account deposits.
Increased focus on fee-based incomeRise in fees for credit cards, lockers, demand drafts, cheque issue, unblocking a card and penalty for bounced cheques.

Besides the interest income, a bank's fortune also depends on the bond rates and bad debts, or NPAs. A fall in interest rates has meant that bond rates have moved favourably, but the rising NPAs could prove worrying. In March 2008, when the bad news had hardly affected them, the average gross NPAs stood at 2.1-2.2%. This figure has risen to 2.5% this year and is expected to reach 3% by next year, says Tarun Bhatia, head of financial sector ratings, Crisil. Much of the bad debt is in the retail segment, particularly unsecured loans and commercial vehicle loans.

So, if a bank's NPAs mount, does it really affect us as ordinary customers? After all, the state of a bank's books should not concern us. Or should it? Sadly, it matters. That is so because if a bank sees bad debts go up, it will become choosy about lending and be very stern about repayments. "Banks are now refraining from lending to the unsecured segment. Credit checks have become stringent," says Bhatia.

Tight lending standards: The process of qualifying for a loan will become more stringent, as will the amount that you can borrow. "Banks have toughened their lending norms. These involve stricter appraisal standards and more conservative LTV and IIRs," says Hitesh Agarwal, head, research, Angel Broking. The LTV is the loan to value ratio, or the amount of loan disbursed against the value of the asset; the IIR is the instalment to income ratio, or the EMI payable against the monthly income. Typically, the margin required depends on the lender's opinion on the valuation of the underlying asset. If he believes that the asset prices are going to come down, the margin will be high, and vice versa. In effect, the LTV ratio depends on the expectation regarding the prices of the asset, the depreciation element and the cushion of default. Since the possibility of delinquencies in today's environment is high, the margin required is higher than before, says J. Moses Harding, executive vice-president, IndusInd Bank. "Gone are the days of 100% LTV ratios. Banks are not lending at more than 90% of the value of the asset today, with the average ratio pegged at 75%," adds Bhatia. The IIR too has come down to a level of 50% from 60% earlier, he adds.

Having said this, it is important to know that every bank has its own credit appraisal and risk management techniques. Harding says that only 20% of an individual's income is considered available for repayment of loan after setting aside 60% for consumption purposes, followed by 20% for medical expenses. While some banks are not reducing the LTV ratio overtly, they are valuing assets on the lower side, so the value disbursed in much lower.

Banks are also becoming more choosy about the borrower's career. They are turning wary about lending to employees of export-oriented sectors such as IT, BPO, gems and jewellery, etc, due to the distinct possibility of loss of business and jobs in these areas. "Excluding small-ticket consumer loans, a customer with a good credit history, proper documentation and repayment capability should not find it difficult to get a loan," says Bhatia. Also, with the growth in credit likely to drop to 12-14% from 20% a year ago, banks may not want to refuse all and sundry.

Close scrutiny of documents: Banks will start becoming even more serious about scrutinising the documents, checking the credit history, and may also want to know the purpose of the loan, adds Bhatia. Downgrading of credit limits and differential rates for defaulters are being enforced.

Risks Associated With Loans
The risk depends on the collateral, borrower’s profile and purpose of borrowing
Credit Cards: There is no form of security. Higher unemployment is bound to affect repayment. Under-developed credit information bureau is set to affect the credit business.
Personal Loans: Post-dated cheques provide the bank with some form of security, but most banks have an unseasoned portfolio, leading to higher delinquency.
Loans Against Shares: Although the underlying asset provides support, the falling share prices and reducing incomes could affect repayment.
Two-Wheeler Loans: High recovery cost due to low-ticket loans and a cumbersome process. Many loans are without proper checks.
New CV Loans: These have a relatively weak outlook due to the fall in business in the current environment. Borrowers will not enjoy the falling interest rates as these loans usually have fixed rates.
New Car Loans: Dealer financing is a low-risk segment and the profile of borrowers will lend support.
Mortgages: The impact of lower interest rate can offset slower income growth. The speed of recovery has improved.

Harding believes that the worst is yet to come. "We are only four to five months into the downturn; things are likely to be affected with a lag of 6-12 months," he says. An analysis of the results of the largest private bank, ICICI Bank, reveals an increase in gross NPAs from 2.96% last year to 4.14% this year. Retail loans comprise 55% of its total credit and it is likely to face higher delinquencies, particularly in the personal loans and commercial vehicle financing business, says Chakraborty. Most banks have seen their NPAs rise in this quarter.

The silver lining: Yes, there is good news even in this climate. For one, you might find it easier to prepay your loan. Earlier, banks opposed prepayments in spite of interest rates up to 35%, but with tightening liquidity conditions and soaring costs of working capital, they will be happy to get their money back earlier than scheduled.

The other area that has so far kept the banks content is mortgages. However, home-loan defaults are now rising mainly due to job losses and loans (mostly given during 2007-8) where a project is under completion. Even here, falling interest rates could provide some relief to borrowers. Edelweiss estimates that a 100 bps dip in the interest rate can help increase cash flows by 6-8% of personal income.

The best news is that the existing borrowers are being offered easy repayment solutions. A firsttime restructuring of loans is the most common way out. The bank extends the loan tenure, reducing the EMI amount, or converts loans to unsecured two-three year demand loans to match the borrower's repayment capability, according to Harding. Another common option is to extend the term of the loan without raising the interest rate, or increasing the EMIs after closing other debts such as personal or auto loans. Depending on an individual's future cash flow, the Axis Bank is allowing borrowers to pledge savings instruments in return for easier repayment terms.

There's good news for investors in banking shares. Analysts believe the sector will soon recover due to the easing of liquidity, low bond yields and expectations of longterm economic revival. Chakraborty prefers PSU banks as the gain from their treasury investments will offset the higher provisioning required to a certain extent. Edelweiss expects the earnings per share (EPS) for large banks to grow at 15% CAGR over 2008-10E, with its top picks being SBI, HDFC Bank, Axis Bank and PNB.

with Rakesh Rai

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