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Indian lending clean-up is the way forward

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By Rashmi Kumar
30 Apr 2014

The Reserve Bank of India is banning banks from helping companies convert their rupee obligations into offshore debt — a move that is expected to put immense pressure on Indian corporates already struggling to refinance loans. It will be hard going but the measures are a step forward in cleaning up the country’s lending system.

India’s central bank announced on April 22 that domestic lenders should not lend through their overseas branches or provide any kind of guarantee to Indian companies if the funds are intended to go towards meeting rupee obligations.

The announcement has created two kinds of worry — deals may simply not fly in the international syndications market without the support of Indian banks, which in turn could lead to borrowers facing a funding squeeze, shut out of international capital markets.

These concerns are not unreasonable. There are already predictions that the rate of non-performing loans (NPLs) from Indian corporates will go up in the next few months, as businesses are unable to roll over their existing loans. India’s NPL ratio has already risen to around 4% in 2013 from a low of 2.3% in 2011, say analysts.

Further increases in NPLs will hurt banks now, but the longer term result will be a better picture of the credit quality of lenders and borrowers.

Paying off rupee debt by converting it into US dollar loans has allowed many companies sweep bad debt under the carpet. And if the loans are being provided by a subsidiary of an Indian lender, then that lender has only managed to shift the risky debt from one bit of its balance sheet to another — without transferring risk out of the Indian banking system.

Now that Indian banks are forbidden from participating in these offshore loans, there should be an improvement in the transparency of their loan books. Foreign currency loans from banks such as Bank of Baroda, Bank of India and Syndicate Bank have grown rapidly since 2012 — in stark contrast to the tepid growth of their domestic loans books, according to Moody’s.

Times are also changing for India. The world’s biggest democracy is currently electing its next prime minister and expectations are high that Narendra Modi, leader of the Bharatiya Janata Party, will win.

If he does, his business-friendly reforms could increase appetite among corporates to expand — and, in turn, their funding needs. Indian banks will be better off attending to their NPLs now to ensure they have sufficient resources in hand to deal with any pick-up in demand.

RBI’s measures will bring a welcome end to some unhealthy window-dressing of loan portfolios. It will be tough for a while, but in the longer term banks will be less risky — and better placed to take advantage of new opportunities.

By Rashmi Kumar
30 Apr 2014