Corporate Debt, a Achilles' Heel for Indian Banks

Mon, 24 Apr Pre-Open

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Credit indebtness of India Inc continues to bog down the country's banking system. Measures taken by the government and RBI have also not met with much progress. What is worrisome is that IMF's Global Financial Stability Report expects India to be among the countries that will see the greatest deterioration in corporate balance sheets.

The report states that nearly one-fifth of the corporate loans have been extended to companies with interest coverage of less than 1. Interest coverage signifies a firm's ability to pay-off debt, where a lower ratio signifies higher risk. In other words, nearly one quarter of the corporate loans are risky and can turn bad. And IMF expects the share to rise by 6.7% on the growing protectionism policies being followed in the developed countries.

Worsening debt profiles of India Inc will spell more trouble for banks saddled with bad loans. One, banks will have to set aside higher portion of their earnings to provide for bad debts. Second, their capacity to extend credit in the future will be curtailed. Again corporate loan write-offs weaken the capital adequacy of banks.

My colleague Vivek Kaul has explained in detail about issues related to corporate loan write-offs:

• Corporate loan write-offs have led to the situation of diminishing bank capital. This has led to the central government having to recapitalise the public sector banks over the years. Between 2009 and now, the amount of money put in has been greater than Rs 1,30,000 crore. This money is ultimately borrowed by the government and leads to crowding out, higher interest rates and a weaker national balance sheet.

Also, more than half of the stressed loan assets belong to the infrastructure, construction, oil & gas, power, real estate and telecom. These are sectors that are normally the pillars for economic growth. If the problem persists, banks will be reluctant to lend to these sectors in the future. This will adversely impact India's long-term growth.

As a measure of safeguard, RBI has recently asked banks to make provisions against good loans in stressed sectors. However, public sector banks battling credit slowdown and asset quality slippages are likely to be further hit by this preemptive measure to cover the risk of default.

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