Wednesday, October 28, 2009

Banks asked to make higher provisions on bad loans (to real estate!)

Indian banks could see their profitability being marginally impacted in the wake of the Reserve Bank of India directing them to set aside more funds as a cushion against losses on loans extended to builders and also to make more provisions on bad loans.

1% of a loan:

Banks will now have to set aside 1% of a loan given to commercial real estate as a provision, up from 0.4% now.

RBI governor D Subbarao has categorized such loans as those given to builders for construction of commercial properties like offices, malls, entertainment zones and hotels.

Interest rates to go up:

OP Bhatt, chairman, State Bank of India, said the interest rate on such loans would go up marginally. Most banks are disbursing loans to builders at prime lending rate (PLR) or at a spread over the PLR.

Low exposure:

Chanda Kochhar, CEO of ICICI Bank, said: “There is no issue of asset bubble as such. The provisioning of loans extended to commercial real estate was high previously. Subsequently, the credit flow to this sector fell, which impacted its activity. Now that the activity has picked up in this sector, RBI has raised provisioning requirement back to the old levels. But banks’ exposure towards commercial real estate sector is low. NBFCs and mutual funds are more active in this space.”

The provisioning for such loans was reduced from 1% to 0.4% after the collapse of Lehman Brothers caused credit lines across banks (globally) to freeze.

Low property prices?:

RBI said the hike in provisioning for such loans was largely due to an increase in the flow of credit to this sector and the extent of restructuring of loans.“Excess of credit to a particular sector is a concern for RBI, and thus, provisioning has been raised.

This will reduce easy access to money (for builders). Hopefully, it should result in builders lowering the price of property, something most have refrained from doing so far,” pointed out M Narendra, executive director, Bank of India.

Provision Coverage Ratio on Bad Loans:

Also, RBI has asked banks to improve the provision coverage ratio (PCR) on bad loans to 70%.

All banks follow asset classification norms, which ranges from 10% for sub-standard to 100% on loss loan. PCR is the overall provision on bad loans.

Simply put, PCR is the amount that the banks expect to forego from a loan if they have to write off that loan account.

However, Mr Bhatt, after a meeting with the RBI, said that banks have requested the regulator to review the entire model of asset classification. He indicated to the media that RBI may give banks more than one year to adhere to the 70% norm.

Among banks, SBI’s PCR is 38% and ICICI Bank’s is 55% as of March 2009, while PNB’s PCR stood at 90%. In fact, early this year, RBI had written to SBI asking it to raise its PCR to the industry average of 52%. But a lower PCR does not mean that the bank has not made adequate provision.
The Economic Times

Related Stories:

1) The days of easy money may fade

2) Interest rates set to rise, signals RBI

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