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Indian banks have effected structural improvements in their risk management capabilities, and while a lot more needs to be done before the modeling approaches under Basel II can be validated, investments in technology have helped improve credit appraisal and loan monitoring capabilities.
Indian banks remain the dominant financial intermediary in the economy. Loans grew 30% y-o-y for the last three years up to end-March 2007 (FY07) on the back of strong economic growth (over 8% y-o-y since FY04, 9.4% in FY07). Rapid loan growth, together with the appreciation in asset prices, led Fitch Ratings to raise the Macro-Prudential Indicator of the Indian banking system to `moderate vulnerability' from `low vulnerability' in September 2006. The central bank too lightened its monetary policy. While loan growth has slowed down, credit demand is expected to remain strong given the investment cycle that is currently underway.
Though the 28 government banks account for over 70% of assets in the banking system, the new private banks have been rapidly growing (11% of assets in FY02, 15% in FY06). The increasing importance of some of these banks is likely to continue given the sizeable equity issuances by the three largest private banks—ICICI, HDFC Bank and Axis Bank—which together raised about US$7 bn in June-July 2007, taking the total equity of these three banks to nearly half the combined equity of all government banks. The government's holdings in many of its banks are close to the statutory minimum of 51%, which restricts the ability of these banks to raise further equity. Issuing hybrid Tier 1 and Tier 2 capital will therefore remain the preferred option for the next two years. The government will, however, soon need to decide whether to reduce its direct shareholding, perhaps in favor of government controlled institutions (such as Life Insurance Corporation of India) or permit non-voting shares. The need for equity will remain foremost, not only to support loan growth, but also to provide for operational risk under Basel II and for pension liabilities that are underfunded in many government banks. |
