Banks bracing for sub-prime spillover

What would be the impact of sub-prime crisis on India. Find enclosed an interest post from Businessline dated 5/02/08. The message : No much direct impact on India, but banks will reduce their exposure to real estate business.



Banks bracing for sub-prime spillover

Impact being felt on export finance, realty advances

C. Shivkumar
N.S.Vageesh


Bangalore/Chennai, Feb. 5 Stalked by fear of the escalating global sub-prime crisis, domestic banks have begun taking defensive measures. The fear is not the global sub-prime crisis itself, but the effects of its spillover.

The impact is already being felt on certain categories of assets, including export finance and realty advances. Some banks, though, are putting up a brave front. “There is no danger here. We are very well insulated,” said Vijaya Bank’s Chairman and Managing Director, Mr Prakash Mallya. “We are continuously monitoring our assets,” he said.

In places such as Mumbai, New Delhi, Chennai, Hyderabad and Bangalore, realty advances and home loans are closely tied to corporates with cross-border receivables, including information technology and BPO sectors. These sectors are potentially vulnerable to the meltdown in the US.

Canara Bank’s Chairman and Managing director, Mr M.B.N. Rao, concurred, “We have provisions for such contingencies and there is no cause for worry.” Mr Rao is also the Chairman of the Indian Banks Association.

Stress-testing


Most large banks already have a capital to risk weighted ratio of 12 per cent. Besides, most of them have large floating provisions. Yet, public sector banks only recently managed to cut non-performing assets to below 2 per cent, through large provisions and recoveries. Few want to revisit the past now.

Consequently, bankers have begun stress-testing their assets, before a financial catastrophe strikes (See box). The Reserve Bank of India provided detailed guidelines for stress-testing in June last year.

Bankers said that the stress-testing of assets or loans was done wherever there were borrowers with large cross border receivables from the US and Europe, exporters and software service vendors. These categories have already been hit by the 12 per cent rupee appreciation.

Overseas borrowings


But not many bankers are worried about exports in the belief that they could recover or adapt quickly with some support from the Government. The worries are mainly from borrowers likely to take an indirect hit due to the meltdown – commercial real-estate and retail housing.

Outstanding advances to commercial real estate were about 3 per cent of gross advances or about Rs 50,000 crore.

Besides, some realty development companies had also raised external commercial borrowings, till last year, when the RBI clamped down on this source.

Some banks had provided guarantees for raising these cross border resources. There is some fear, that in the event of defaults on the foreign borrowings, guarantees could be encashed.

There are no readily available numbers on the guarantees provided to some of the housing companies. Bankers admitted that if these elements were also included, exposures to the commercial real estate sector were likely to be closer to about 5 per cent of the gross assets.

Asset delinquencies


Retail housing exposure of banks is about Rs 3 lakh crore. Many banks forestalled potential delinquency last year, by restructuring and rescheduling loans, after the interest rate spikes last year. Bankers, however, anticipate asset delinquencies to rise in the coming months, as the US meltdown worsens, especially so from BPO sectors where bankers are now bracing for job losses.

Home loans with underlying borrowers in vulnerable categories could become sub-standard assets. Given the grim situation Mr Mallya was blunt. “We are not going to lend to these sectors. Wherever possible, we will continue to reduce exposures.”


Portfolios put through ‘stress tests’

Just as a doctor would put you through a treadmill to make your heart beat faster and record observations about your health, banks are putting their portfolios through various kinds of ‘stress tests’.

Using these tests, banks test the strength of their systems and their capacity to withstand shocks that can come from the external environment. They also identify the amount of capital that would have to be infused if such a scenario were to play out.

Asked about the kinds of ‘stress tests’ carried out Andhra Bank, Dr K. Ramakrishnan, Chairman and Managing Director, said these included testing the investment (trading) portfolio, testing of forex risk (assuming the rupee appreciates or depreciates by 5 per cent or 10 per cent), testing of liquidity risks (assuming, for instance, that there was premature closure of deposits or a decrease in renewals), besides testing of interest rate risks.

Giving some examples of scenarios and stress events, Dr Ramakrishnan pointed to the terrorist attacks on WTC and the Indian Parliament that led to an immediate reaction in the bond and equity markets.

Results


On the results of these stress tests, he had this to say: “The results of stress tests do not indicate any major threat to the bank’s overall profitability and capital adequacy, though under extreme stress conditions, the parameters do take a small hit.”

Mr M.V. Nair, Chairman and Managing Director, Union Bank of India, explained the stress tests for credit risk. He said, “These scenarios would cover different levels of rating downgrade, increase in provisioning rate for all asset classes, movement of advances from standard to sub-standard category, different delinquency rates, increase in interest rates and fall in housing prices and impact on home loan portfolio.”

So how did the bank fare? Not too badly.

Mr Nair said, “Based on the tests conducted, it was found that our bank might require additional capital that would range from Rs 2 crore to Rs 60 crore.

The impact on the capital adequacy ratio would be in the region of 15 to 40 basis points.”

Similarly, for forex risk (appreciation and depreciation of the rupee at varying levels), it was found that the impact on capital would be of the order of between Rs 0.20 crore and Rs 0.60 crore, while the profits would be impacted by about Rs 0.70 crore to Rs 2 crore. (Union Bank reported a profit of Rs 365 crore for the third quarter ended December.)

Action


So what do banks do with the results? They have policies that place limits on exposure, fix stop-loss limits (trading portfolio), maturity and gap limits, Value at risk (VaR/ Net open position limit), besides having a contingency funding plan for emergencies. The banks’ asset liability management committees monitor these limits regularly.