Can our banks weather the financial crisis?

People today want simple and straight answers to assuage fears on the safety of their money in banks, in the wake of the US crisis.

Banking esoteric and beatings around the bush only confuse them more and compound the scare. The widespread anxiety is neither unreasonable nor disproportionate. After all, 55% of household savings in the country are parked in banks.

People choose to keep their hard earned money in banks despite low returns due largely to a high level of trust in the banking system.

The savings aggregate to lakhs of crores of rupees. Indeed, as per RBI data, the outstanding amount of deposits in scheduled commercial banks was Rs 34.05 lakh crore as of September 12, which is equal to 80% of the gross domestic product.

More than the assurances of the prime minister, finance minister and the RBI governor on the safety of the banks and the money therein, it is accurate information on the uses this public money is put to by the banks holding it in trust that would satisfy people. But, where does one get this information? Aggregate data compiled by the RBI could give some insight. So can the balance sheets of different banks, although these are neither intelligible to all the lay depositors nor provide enough clues on what is happening in the bank.

Yet, these figures are worth looking at. Banks in India have acquired enough capital; they have achieved, on average, a 13% capital adequacy ratio, 4 percentage points over the mark stipulated by the Basel-II norms. That means their share in the business is to the extent of 13% of the risk weighted assets (roughly meaning the loans they give).

All the scheduled commercial banks put together (public sector, private and foreign) have extended credit - loans, cash credits, overdrafts and bills purchased - of Rs 24.91 lakh crore, which is equal to about 73% of the total deposits. They invested about Rs 10.05 lakh crore in securities, including Rs 9.86 lakh crore in Central and State government securities and 0.19 lakh crore or so in other approved securities.

Banks in India are under a statutory obligation of keeping a portion, at present 25%, of their deposits in the form of cash and government securities, which are considered to be safe areas of investment. This is called the statutory liquidity ratio (SLR).

Similarly, they need to deposit with the RBI, as decided by it from time to time, a portion of their deposits in cash. This is known as the cash reserve ratio (CRR) and is currently at 6.5%, following the recent 2.5% reduction.

Such measures, designed to protect the depositors’ interests while ensuring adequate liquidity to the banks, are not available in the US. While our banks are allowed to use only two-thirds of the deposits, the US banks lend five to six times the deposits they accept. This means there is ample scope for reckless lending in the US. Their subprime lending - lending without regard to the repayment capacity of the borrower and adequate security against the loan given - was the root cause of the present turmoil. Indian banks do not have a scope for this type of lending and are therefore safe to this extent.

And what the US banks are doing as a damage control measure has long been in place in India. The US is seeking a kind of nationalisation of banks with a $700 billion package, which is equal to the aggregate deposits of Indian banks or 80% of India’s GDP, worked out at the current exchange rate of over Rs 49 per dollar. Only, Indian Banks are largely in the public sector, which accounts for 74.2% of the deposits and 73% of the advances.

But, it is naïve to think that our financial system, of which banks are an important part, will remain totally unaffected once they are allowed to have overseas exposure.

The stock markets have taken a direct beating. There was a boom when the foreign institutions invested heavily and there was a bust when they sold heavily to meet their obligations following the US crisis. The heavy demand for dollars made them dearer in rupee terms, resulting in a steep fall in the Indian currency.

Banks have dealings related to the stock market, so they are not totally outside the danger zone. But, by how much, is the question.

Though the balance sheets which we talked about do not provide clarification for every single doubt, they give some vital information and scope for useful inference. The amount shown under ‘off balance sheet items’ or the ‘contingent liabilities’ of all the public sector banks aggregated to Rs 18.57 lakh crore in 2007-08, a 46.16% increase over 2006-07’s level of Rs 12.70 lakh crore as per the Indian Banks Association’s (IBA) report on public sector Banks.

In a similar publication on private sector banks, the IBA found that these banks have much bigger sums involved under the head. All the private sector banks put together had Rs 23.61 lakh crore in 2007-08, higher by 77.53% compared with the 2006-07 figure of Rs 13.30 lakh crore. The 16 old private sector banks have Rs 1.11 lakh crore contingent liabilities, whereas the eight new private sector banks account for a whopping Rs 22.50 lakh crore.

ICICI bank, the largest private sector bank in the country, tops the private banks list with 48.76% share. More interestingly, the ICICI Bank’s Rs 11.51 lakh crore off balance sheet amount is 288% higher than its balance sheet size of Rs 3.99 lakh crore.

Also, there is a quantum jump in these liabilities from Rs 5.62 crore last year.
Among public sector banks, SBI’s share in the contingent liabilities was the highest at 43.66%.

Although this bank’s off balance sheet transactions are higher than its balance sheet size, they are not as large as those of some private sector banks including ICICI. SBI’s contingent liabilities of Rs 8.10 lakh crore in 2007-08 work out to about 112% of its balance sheet size of Rs 7.21 lakh crore.

The off balance sheet items also include derivatives, forward contracts and currency futures, which are not easily understood by the common man, but which have inherent risks all the same.

So, the Reserve Bank has recently (notification dated October 13) and rightly so brought these off balance sheet under the scanner of prudential norms and directed for provisioning of the specific items under the head. The impact of this measure will only be discerned in the 2008-09 balance sheets.

All these facts suggest that there is an urgent need for a thorough scrutiny - a bank by bank examination - to take timely and preventive measures needed to put the house in order and to lend credence to the assurances given by the government and the RBI.

The threat created by the US crisis may be converted into an opportunity, through timely measures, to better safeguard the banks and the public savings in them.
raopsmrao@gmail.com