Banking Scorecard: Who Was Hit The Hardest By The Asset Quality Review?

In January 2016, Raghuram Rajan, then governor of the Reserve Bank of India (RBI) asked banks to clean up their books by March 2017. The RBI had undertaken an asset quality review (AQR) of the sector in the second half of 2015 and found that banks were under-reporting stressed assets. What followed was an effort to get banks to classify loans appropriately, provide for them and move towards resolving the pile of bad loans that had been allowed to lurk in undeclared corners of bank books.

With that process near completion, it is now clear that the reported asset quality ahead of the AQR was far from the real picture. A comparison of data reported for the recently concluded December 2016 quarter with the results of the September 2015 quarter (before the AQR was conducted) shows just how much banks were hiding.

Bad Loans Have Doubled

Gross non-performing assets (NPAs) of the 42 listed banks added up to just over Rs 7 lakh crore at the end of the December 2016 quarter. This compares to gross bad loans of about Rs 3.4 lakh crore at the end of the September 2015 quarter.

A caveat - the gross NPAs at the end of the December 2016 quarter include those of IDFC Bank which only listed in December 2015. As such, the gross NPAs of IDFC Bank (which stood at Rs 1,462 crore in December 2015) have not been included in the calculation of the September 2015 gross NPA number.

Private sector banks accounted for Rs 80,409 crore of the bad loan pile at the end of December compared to Rs 33,634 crore in September 2015 before the AQR. In the case of public sector banks, gross NPAs are at Rs 6.2 lakh crore compared to Rs 3.06 lakh crore in September.

The data shows that both public and private sector banks were guilty of hiding the true quality of their balance sheet. It also reflects the fact that a number of banks have exposure to the same set of over-leveraged entities that have led to a build-up of banking sector stress.

Which Banks Were The Worst Offenders?

While the aggregate data shows that bad loans were under-reported by half at a system level, some banks have seen a steeper uptick in bad loans than others. Banks which were lending heavily to sectors like iron and steel, power and infrastructure have predictably seen the steepest jump in gross NPA. However, even within this subset, some banks have been impacted more than others.

Axis Bank has seen the sharpest jump in its gross NPAs in percentage terms. Others in the list of ten banks that have seen the biggest increase in bad loans include the three listed associate banks of the State Bank of India, which have aligned their reporting standards to their parent company ahead of a planned merger. While not in the top ten list, State Bank of India has seen its reported bad loans jump by 90 percent as a consequence of the AQR.

ICICI Bank also falls in this list with a 137 percent increase in bad loans.

Which Banks Are Most Vulnerable?

While some private banks have also seen a significant increase in bad loans, public sector banks are more vulnerable as a higher proportion of their books have gone bad. Some of these banks also have low capital adequacy ratios which makes it difficult for them to make adequate provisions against bad loans. The lack of capital also makes it difficult for state-owned banks to continue growing their loan books, which, in some cases, has helped private sector keep the gross NPA ratio low.

Indian Overseas Bank has the highest gross NPA ratio at over 22 percent. It’s capital adequacy ratio stands at 10.78 percent, close to the minimum required level. Current norms under Basel-3 require banks to maintain a minimum capital adequacy of 9.625 percent and a Tier-I ratio of 7 percent. This will go up to 10.25 percent starting March 2017.

Other banks that have worrying high gross NPA ratios include IDBI Bank with a ratio of 15.16 percent. On Tuesday, rating agency Standard & Poors downgraded IDBI Bank citing "very weak asset quality" at the bank. IDBI Bank, along with Indian Overseas Bank, are the two lenders classified as “very weak” by the rating agency.

Is The Worst Over?

With the asset quality review close to concluding, the pace at which bad loans are piling up at a system level is slowing. Gross NPAs have risen 4.4 percent between the September 2016 and December 2016. The increase was steeper at 6.6 percent between the June 2016 and September 2016 quarters.

Still, bad loans at banks may continue to rise, partly due to an organic addition to NPAs. In addition, incremental stress in sectors like power and telecom may push accounts from those sectors into the bad loan category. Some stress is also being feared in the small and medium enterprises segment as a consequence of demonetisation.

The RBI, on its part, is fearing that ratios may hit double digits. It expects bad loans to account for 10 percent of total loans by March 2018.

Note: This article has been altered to correct the capital adequacy ratio needed to be maintained under Basel-3 norms to 9.625 percent.