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Are Indian banks too big to fail in times of crisis? - Views on News from Equitymaster
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  • Apr 15, 2014

    Are Indian banks too big to fail in times of crisis?

    Think of 2008 and we are reminded of the Lehman fall. The 2008 financial crisis as we know saw the downfall of big banks of Wall Street. It required massive rescue operations to get the US financial system back on track that went haywire then.

    Back home, India had come unscathed out of the 2008 global crisis. Thanks to the Reddy regime and the then conservative banking practices! We stood guarded. But the scenario today is more fragile. Indian economy is growing at its slowest rate in the decade. Moreover, the Indian banking system is plagued by pile up of stressed loans. Hence the red flags have been raised again. And this time the Regulator is leaving no stone unturned in doing the right things. Because when the catastrophe strikes, there is no time to remorse.

    Why the need for further stringent guidelines?

    Whether it's US or India, big banks continue to reel in threat particularly during crisis periods. And any problems faced by large and highly interconnected financial institutions hamper the financial system. This in turn disrupts the real economy.

    Hence, RBI plans to tighten the ropes and intends to stabilize the big financial institutions. BASEL III norms have already been put in place in response to the global crisis. Improving risk coverage, introduction of leverage ratio and increased risk-based capital has already been made mandatory. But as cited by RBI, the current policy measures stand inadequate to counter the systemic risks posed by the large banks. Moreover, the imperilments caused on account of an unstable financial institution can jeopardize the whole system in times of distress.

    What are SIBs?

    So to avoid the repeat of 2008 wrath, the Reserve Bank of India (RBI) has decided to set up a separate category of "too big to fail" or systematically important banks (SIBs). According to RBI, few banks are of systemic importance on account of their size, complexity and interconnectedness. These banks are considered systematically important since the continued functioning of their services keeps the real economy going. But this very penchant of large banks of mammoth size and complex structures becomes their undoing. Because when these banks fail, they have far-reaching repercussions for the entire economy. The Regulator, therefore, plans to introduce stringent capital norms and differentiated supervisory requirements for SIBs. Under the new norms, SIBs may have to maintain higher common equity as part of Tier I capital ranging from 0.20% to 1.0% of risk weighted assets. The Regulator has also insisted upon maintenance of counter-cyclical buffers. Setting aside these reserves in good times will help banks sail through tough tides. Also these large institutions will be under constant scanner of the Regulator. Time and again they will have to undergo stress tests.

    To what extent are Indian banks exposed to risks?

    India has so far not been acutely affected by the recent turmoil in developed economies. But a crisis is too important to waste. And banks form part of the core of the financial sector. Hence, they need to be prepared for the worse. Here we would like to touch upon certain risk factors emanating from a financial crisis that can threaten the very existence of banks.

    The global financial crisis threw up two major challenges. These are capital and liquidity. During a crisis, liquidity risks can rise manifold and can pose serious downside risks to the entire financial system. Secondly, banks largely rely on borrowed funds. This can exacerbate vulnerability to external shocks. The subprime crisis is a case in point. Few Indian banks had invested in the collateralized debt obligations (CDOs) and bonds which had few underlying entities with subprime exposures. These banks suffered major mark-to-market losses arising from the subprime episode. This was widely evident in the 2008 financial crisis. And we learnt the harsh lessons. At such times maintaining a stable credit-deposit ratio becomes critical. Essentially this ratio indicates the extent to which banks are funding credit with borrowings from wholesale markets. Thirdly, asset liability management that takes into account both on and off balance sheet items needs to be up to the mark.

    Many Indian banks today have accelerated exposures to sensitive sectors of the economy such as real estate and capital markets. Also, top private banks and others are exposed to off-balance sheet items including derivatives. As on today the complex credit structures like synthetic securitization has not been permitted in India. But as we march towards global banking practices, the possible exposure to complex structures cannot be ruled out.

    Group-wise Indian banking exposure:
    2012-13 Public Sector Banks Nationalised Banks State Bank Group Private Sector Banks
    Off-Balance Sheet Exposure Amt in Rs bn % to total liabilities Amt in Rs bn % to total liabilities Amt in Rs bn % to total liabilities Amt in Rs bn % to total liabilities
      31,104 44.7 20,420 41.7 10,684 51.7 27,194 136.7
      Amt in Rs bn % to total loans Amt in Rs bn % to total loans Amt in Rs bn % to total loans Amt in Rs bn % to total loans
    Total Advances to Sensitive Sectors 6,539 14.6 4,166 13.5 2,372 17.2 2,883 25.2
    Table Source: Banks, RBI

    The above exhibit tells us that as at the end of FY13, the off-balance sheet exposures of public sector banks formed almost 45-50% of their total liabilities. Also these exposures as a percentage of total liabilities stood at higher levels of 137% for private banks. This tells us that Indian banks do carry significant risky exposures on their books. So it's imperative for them to remain sanguine about the risk management practices in order to maintain a stable asset liability match.

    Let's take a glimpse at few top Indian banks that could possibly fall under the perimeter of new regulations. Banks with functions other than core banking such as insurance, broking and asset management may fall under this category. Large banks such as State Bank of India (SBI), ICICI bank, HDFC Bank, Axis bank, Canara Bank and Punjab National bank (PNB) are likely to be termed as SIBs. Multiple financial services and risky nature of the business model make them more vulnerable in uncertain times. Can they pass the stress tests? Have a look at the key parameters of these banks.

    Top 6 banks that might fall under the purview of new guidelines:
    KeyParameters (2012-13) State Bank of India Punjab National Bank Bank of Baroda ICICI Bank HDFC Bank Axis Bank
    Total Assets (Rs bn) 15,663 4,789 5,471 5,368 4,003 3,406
    Lending to sensitivesector (Rs bn) 1,908 561 347 1,157 376 684
    Contingent Liabilities(Rs bn) 9,264 2,143 2,046 7,900 7,201 5,481
    Total Risk WeightedAssets (Rs bn) 3,244 3,048 4,419 3,059 2,584
    Total Capital AdequacyRatio (%) 12.9 12.7 13.3 18.7 16.8 17.0
    Tier I Capital  (%) 9.5 9.8 10.1 12.8 11.1 12.2
    Tier II Capital  (%) 3.4 3.0 3.2 5.9 5.7 4.8
    Provisioning coverageratio (%) 66.6 58.8 68.2 76.8 80.0 79.0
    Credit to Deposit  (%) 86.9 78.8 69.3 104.8 80.9 78.1
    Assets to Equity (x) 15.9 16.3 17.4 10.0 11.2 11.2
    Table Source: Banks, RBI

    While the private banks stand adequately capitalized, the off balance sheet exposures stand significant. Public sector banks on the other hand need to expand their capital base. Moreover, the nationalized banks also need to beef up their provisions to build-up a resilient portfolio. Therefore, while private lenders need to be cognizant about their risky exposures, public sector lenders need to strengthen their balance sheet. Given this scenario, we believe the above guidelines have come at the opportune time. The regulator's objective seems apparent. If the history were to repeat, Indian financial system should be geared up to rise unhurt once again. Having said that, investors need to be extra careful about their choice of stocks from the sector.



    Equitymaster requests your view! Post a comment on "Are Indian banks too big to fail in times of crisis?". Click here!

    2 Responses to "Are Indian banks too big to fail in times of crisis?"


    Jan 4, 2015

    The watch dog RBI has a sound controle on Indisn Banking Sector.
    So, no worry to investors

    Like (3)


    Apr 20, 2014

    nO.Becaus Indian banks have sound structure and proper control.

    Like (3)
    Equitymaster requests your view! Post a comment on "Are Indian banks too big to fail in times of crisis?". Click here!

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