Wednesday, October 15

Banking Industry - Reasons to smile amidst challenges

The statements issued by the Prime Minister, Finance Minister, RBI Chief and Bank chairmen have at least some truth in it. This is seconded by the recent Crisil report. But again, there are two sides of a coin. The report says that the global crisis is not responsible for the challenges faced by the Indian Banks; but at the same time, there are a lot of internal factors that are responsible for the same.

Contrary to the stance taken by authorities, ratings major Crisil has said domestic, not global factors are responsible for the current challenges facing the banking sector. In a statement issued on Tuesday, the ratings agency has said: “Crisil believes that the Indian banking system is relatively insulated from factors leading to the turmoil in the global banking industry.” The statement goes on to add that the recent tight liquidity in the Indian market is also qualitatively different from the global liquidity crunch, which was caused by a crisis of confidence in banks lending to each other.

Crisil managing director and chief executive officer Roopa Kudva said: “While the main causes of global stress are less relevant here, Indian banks do face increased challenges due to domestic factors.

The banking sector faces profitability pressures due to

  • higher funding costs,
  • mark-to-market requirements on investment portfolios, and
  • asset quality pressures due to a slowing economy.”

But the strong capitalisation of Indian banks is a positive feature in the current environment. Problems of global banks arose, mainly due to exposure to subprime mortgage lending and investments in complex collateralised debt obligations whose values have eroded sharply over the past few months. Globally, the crisis of confidence among banks that has also been affected by the freeze in the inter-bank lending market.

Reasons to smile

Indian banks have limited vulnerability. Indian banks’ global exposure is relatively small, with international assets at about 6% of total assets. Even banks with international operations have less than 11% of their total assets outside India.

The reported investment exposure of Indian banks to distressed international financial institutions of about $1 billion is also very small.

The mark-to-market losses on this investment portfolio, will, therefore, have only a limited financial impact.

Indian banks’ dependence on international funding is also low.

The reasons for tight liquidity conditions in the Indian market in recent weeks are quite different from the factors driving the global liquidity crisis. Some reasons include

  • large selling by foreign institutional investors (FIIs),
  • subsequent Reserve Bank of India (RBI) interventions in the foreign currency market,
  • continuing growth in advances,
  • earlier increases in cash reserve ratio (CRR) to contain inflation.

RBI’s recent initiatives, including the reduction in CRR by 150 basis points from October 11, 2008, cancellation of two auctions of government securities, and confidence-building communication, have already begun easing liquidity pressures.

Being an optimist citizen and a strong believer in the government policies, I hope things should turn out well and investors should gein confidence in the Indian Banks soon.

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