The global financial crisis did not affect Indian banks the way it impacted global banks. The major reason for this was the strict set of Reserve Bank of India (RBI) regulations that these banks had to adhere to which prohibited extensive use of securitization and derivatives. But that does not mean that Indian banks are completely out of the woods. Indeed, they are facing problems of another kind. Notably that of bigger bad debts.
The Economist points out that India has a bigger bad debt problem that is not in line with what is stated by the rather stable level of banks' official 'non-performing' loans. But the quantum of this debt is difficult to judge because many have been labelled as 'restructured'. This means that the terms of the debts have been softened, but they are not formally recognised as bad debts. These restructured loans were estimated at US$ 43 bn in March this year amounting to around 2% of India's GDP. Restructuring loans by itself is not such a problem simply because the borrower has not defaulted but simply requires easing of the terms of repayment. But the important thing to note here is that this facility should not be misused. For instance, take the case of struggling airlines such as Air India and Kingfisher Airlines. Both of them are saddled with massive debt. While they may not have technically defaulted so far because of restructuring of these debts, they are certainly in no position to service or repay the debts.
Also, the burden of these debts has been greater for public sector banks than their private peers. The Economist has estimated that 93% of restructured loans are on the books of public lenders. They tend to be in poorer shape than their private rivals on account of lower capital levels, lower profitability, higher bad debts and lower provisions held against those bad debts.
However, it would be too early to presume that the problem of restructured loans could blow into something very big. At least we hope that the central bank which has been rather vigilant so far will ensure that this issue does not blow out of proportion. Moreover, since Indian banks (even PSUs) are comparatively better capitalized as compared to their Western peers, they are in a better position to tide over difficult times. Having said that, a consolidation in the sector cannot be ruled out. Overall, what banks need to ensure is that they do not stop lending to genuine borrowers just because they have been bitten by a few bad ones.