Indian banks get more life support from the RBI

On Friday, January 2, 2008 the RBI relaxed prudential norms for recognition of bad loans by banks. The move will allow banks to hide their bad loans for a much longer time, even as they hope that the borrowers’ economic condition improves and they pay back or recover their dues through other means.

Either way, banks are sure to report a much better set of results in the coming quarters, compared to what they normally would have. Falling interest rates will also swell book profits on their government securities portfolio, promising hefty net profit jumps. Of course, that all these profits are illusory is another matter altogether.

The changes:
1. In December, the government allowed commercial real estate loans to also be classified as standard, even after restructuring. This means banks sitting on troubled real estate loans could restructure without having to provide for them, which would otherwise hit their net profits. This relaxation was given to certain other loan classes in the August circular. Banks wanted this benefit to given to loans that turned bad after September and not just those after December.

The RBI has agreed and said that commercial real estate loans which were standard as on Sept 1 will continue as such, even after restructuring. The restructuring should begin before Jan 31, 2009 and the package should be finalised within six months. This period was earlier three months and has been extended for all categories.

2. Another request pertains to falling inventory prices, leading to conversion of irregular working capital loans into working capital term loans. But such loans need to be secured by collateral, otherwise even after restructuring they will be treated as NPAs. The RBI has relaxed this condition too: even for the unsecured portion of working capital term loans, it will not be treated as NPAs, but the banks will have to make a small provision of 20% in the case of standard assets and for sub-standard assets, 20% every year for five years.

This basically gives the bank five years to provide for bad loans. In sum, these provisions will allow banks to keep their NPA levels down. While these may be exceptional circumstances, relaxing NPA guidelines in this manner brings into question the whole issue of prudent banking. These guidelines will put even those banks which have a good loan book on par with those who don’t, and as for investors they will be left wondering if their bank is really as good as it appears on paper. It also leaves those borrowers, who have been regular in their repayments, wondering whether it was worth the bother. RBI’s press release on further relaxation of provisioning norms, the December circular and the August circular.

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