Rating Change to Hurt India Inc & Banks: RBI

Act Now! Central bank underscores the big risks facing Indian economy even as PM's statements in past two days spur action on policy front

Dollar-borrowing costs for Indian companies and banks could soar, straining their already-fragile finances, if rating companies downgrade India's sovereign rating that is just a notch above junk. 
"A rating change could have some 'cliff effects'," the Reserve Bank of India (RBI) said in its Fifth Financial Stability Report, referring to the consequences of a possible rating cut. "This could affect both availability and cost of foreign currency credit lines for Indian corporates further. The impact is also being felt by Indian banks as they are the primary source of foreign currency-denominated funding for Indian firms like buyer's credit." 
Standard & Poor's has said India could be the first among the so-called BRIC nations to get downgraded to junk status and become a 'fallen angel' if it does not set its fiscal house in order. Fitch and Moody's have also expressed their concerns about deteriorating macroeconomic fundamentals. 
The worsening economic climate could bloat the banking sector's bad loans, though available capital buffers could help them withstand a shock, the RBI said. Bad loans may rise to 4.6% of total loans in March 2013 in the most severe risk scenario, up from 2.9% at the end of March 2012. Under normal scenario, it could range between 3.3% and 3.5%. Banks' increasing reliance on mutual funds and insurance companies for funds is an indication of rising risk in the system, which could amplify the instability of the financial system during times of stress, the half-yearly report said. 
"Banks with higher credit deposit ratio are running short of resources," said JP Dua, chairman and managing director of Allahabad Bank. "Sectors like steel, realty and infrastructure are the most vulnerable now as the economy's growth is slowing. Credit risk can be higher in these sectors, but it all depends on how one manages the portfolio. There are banks with high exposure to the infrastructure sector, but without any issues over asset quality." The central bank also called for an overhaul of regulations across the financial spectrum consisting of banks, insurance companies and mutual funds since trouble for one could spell trouble for the entire system. Credit Risk Bigger Worry 
"A complete macro-mapping of all kinds of credit intermediation activities would be warranted in the light of international reforms in this area," the report said. "There are concerns posed by the degree of interconnectedness of these entities with the banking system, which could pose credit and liquidity risks. The disproportionate slowdown in deposit growth vis-à-vis credit growth led to increased reliance of banks on borrowed funds, which may translate into liquidity risks." Credit risk will remain a bigger worry for banks than interest rate risk as bad loans grew nearly three times faster than credit in the last fiscal, it said. Bad loans have to be monitored closely since a combination of declared bad loans and restructured loans provides an ugly picture, given that 15% of the latter category of loans may also turn bad. "The muted economic backdrop and global headwinds could lead to further deterioration in asset quality," the report said. "The position is not alarming at the current juncture and some comfort is provided by the strong capital adequacy of banks, which ensures that the banking system remains resilient." 
In the past year, the potential loss to banks' capital from the failure of the 'most connected' banks has risen to 16% of the total capital, from 12% in March 2011, the report said. 
The rising short-term borrowings of banks at 27% of the total and the sector's reliance on mutual funds and insurance worry the RBI. "The largest net lenders in the system were insurance and asset management companies while banks were the largest borrowers," it said. "This renders the lenders vulnerable to the risk of contagion from the banking system."