November 9,1998

The fear of rising bad loans and problems of recovery in leading banks and financial institutions send scrips on an unprecedented slide.

By V Shankar Aiyar

The day before the markets closed for Diwali, the Sensex crashed by 89 points and took 15 scrips to their lowest ever price. Among them were those of 11 banks and three leading financial institutions (FIs). While the pre-Diwali slide may have brought the stocks into focus, the fact is banking and fi scrips have lost between 38 and 20 per cent of their value in under 30 days.

The lenders are under fire. The fall has been astounding in the fi shares. ICICI, IDBI and IFCI have lost over Rs 10,000 crore in market cap between April and October. Add to this the erosion in the market cap of State Bank of India (SBI), Bank of India, Bank of Baroda, Dena Bank and Corporation Bank and the money lost would be over Rs 22,000 crore in just six months. The scrips are sliding even further. ICICI, IDBI and IFCI -- at Rs 39.60, Rs 37.65 and Rs 17 -- are quoting at a third of their book values. Or as Dalal Street would put it, at "sau ka teen".

This is not without reason, say market analysts, who fear that the banks are either hiding or covering up huge tranches of non-performing assets (NPAs). Bad loans have risen. In ICICI, the figure has gone up from Rs 1,950 crore in March 1997 to Rs 2,810 crore in March 1998 and in IDBI from Rs 4,370 crore to Rs 5,110 crore.

According to research reports, the financial sector scrips had been overvalued. Merrill Lynch has advised investors to reduce their exposure to financial sector stocks due to "heightened concern over asset quality" or rise in bad loans. A report by Kotak Securities forecasts "subdued earning per share (EPS) growth and increase in non-performing loans (NPLs)". The report also states that currently "NPLs equal about two-thirds of the net worth of ICICI and IDBI after a substantial increase during fiscal 1997 and 1998" and that with overall corporate profitability and liquidity likely to stay poor in fiscal 1999 this is a cause for concern.

The slide has hardly been surprising, even if the bankers feel so. After all, industrial output figures were falling, the National Council of Applied Economic Research index of business confidence was at its lowest and the GDP growth forecast too had been revised. Then there are the fear overs the NPA positions expressed earlier in the year by global rating agencies like Standard and Poor. The Reserve Bank of India (RBI) too had cautioned banks on following provisioning norms last month. Concerned over the rising NPAs, it announced later that the capital adequacy ratio of banks would be hiked from 9 per cent to 10 per cent in a phased manner. "The simple fact," as a senior IDBI official point out, "is that if the borrowers are in trouble, the lenders cannot be insulated from the same."

While rising loans have always been a concern, it is the worsening industrial environment, says Amit Rajpal of Morgan Stanley India, that has brought the financial sector into focus. Since banks and long-term lending institutions have significant exposure in commodity and other industrial segments, the market was bound to take a view on it. Rajshekhar Iyer of Kotak Securities adds: "There is a perception that banks and FIs have underprovided. Also with the quality of corporate assets deteriorating, there is concern about rising NPLs. The values in the market are basically reflecting these concerns."

In fact, marketmen expect worse. Reason: recession brings along a drop in greenfield and profitable "vanilla" projects. Plus there are fears that FIs in the past two years have indulged in "evergreening" -- rescheduling and rolling over -- of loans. Investors and analysts doubt the transparency of the banking system itself. Except perhaps in the case of HDFC and Oriental Bank which are doing better than the others. Says Deepak Parekh, HDFC chairman: "We have always been totally transparent and I believe the investors trust us."

One reason why market is so sceptical is perhaps because its real fears have not been addressed. Investors lost badly when bank stocks went down in South-east Asia, Japan and in US. Expecting a similar fate in India, investors may be opting out of what they see as a risky sector. Particularly when institutions like IDBI borrow at 14 per cent through bonds, well in excess of the prime rate of 13.5 per cent.

There are some who feel the market is over-reacting. Ravi Mohan, CEO of CRISIL, says while "there is concern over non-performing assets, stock prices have been dragged down well beyond justifiable levels". Historically, he adds, there have been write-offs of about 1 per cent and the current market valuation would suggest that at a third of book value there has been an erosion of net worth of over 60 per cent. "The concern is overstated."

May be so on current valuations. But the stock market is looking at the future. A former RBI official points out that typically the NPA norms are not as stringent as they ought to be. As of now, it is only after a default through two successive quarters that a loan is deemed an NPA. Further, the law doesn't require any provisioning made for the next two years. Thereafter, the asset is classified as "sub-standard" and 10 per cent of the value is provided for. If the asset doesn't yield returns for two more years, it becomes "doubtful". If it stays this way for over three years, the loan is a "loss asset" and 100 per cent of the historical value has to be provided for.

In short, the borrower gets a breathing space of well over five years from the time he defaults. And it is in this breathing space that over Rs 45,000 crore of NPAs are stuck. Banks have in fact provided Rs 20,000 crore in their books and have gone to court for recovery. RBI officials state that even though nearly 70 per cent of the money is recoverable, the banks cannot do much given the fact that the cases are stuck in court or the debt recovery tribunals. This aggravates the fears of investors who feel that regulation has failed to keep pace with events. Indeed, Merrill Lynch analysts aver that "significant reforms such as dealing with past stock of bad loans and new bankruptcy laws remain low on the policy agenda".

It is not as if the RBI or banking experts are unaware of that. The various recommendations made by the Narsimham Committee included changing NPA recognition norms, slashing government holdings in banks and forming an asset recovery fund. But the banks and FIs are caught in a bind. While they recognise that a sound financial system is the key to avert crises, they cannot do much since the decision to implement reforms rests with the Government. And the Government is busy toasting to the fact that it has escaped the global contagion. At least for now.

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