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India's Achilles' heel?
Mon, 20 Jul Pre-Open

The woes of India's banking sector are well known. PSU banks in particular have been shunned by the investing community. Rightly so we believe. The huge NPA overhang refuses to go away. The unprofessional, inefficient and corrupt ways of this industry hasn't changed much over time. So it did not surprise us when former deputy governor of the RBI, Usha Thorat, stated recently that Indian banks were the weak link of the economy.

The recent UBS report about the health of the Indian banking sector caused a bit of a sensation. It implied that private sector banks were not far away from their PSU counterparts in terms of the bad loan menace. While some banks rubbished the report, it certainly challenged the perception that fundamentals of the sector were improving.

On top of all this comes the financial stability report of the International Monetary Fund (IMF). As per an article in the Mint, this particular report paints a disgraceful picture of India's banking system. At the heart of the report lies a term called 'debt-at-risk'. This is quite simply the share of corporate debt that comes from firms with an interest coverage ratio (ICR) less than two. Interestingly, the IMF has calculated the ICR using EBITDA rather than EBIT which is more appropriate. Despite this leeway, India's position is horrible. India ranks only above one country, Nigeria, in terms of 'debt-at-risk'. The IMF concludes that nearly 40% of all corporate loans in India's banking sector could be at risk!

These numbers truly boggles the mind. One wonders if India's banks even know the basics of credit appraisal. When you couple such figures with falling growth in core operating income (i.e. net interest income) as well as deteriorating financial ratios, the situation becomes very worrisome.

We believe there is no easy way to clean up this mess. The government's response, despite making all the right noises, has been found wanting. FIIs are losing interest in PSU bank stocks. Their concerns are genuine. Without a healthy banking system, India's dreams of achieving high GDP growth will just that, a dream. And a distant one at that we believe.

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