The subprime crisis ripples have started to touch Indian banks too. The country's second largest bank, ICICI has recently announced a Mark-to-Market (MTM) loss of $263 mn in its loans and investment exposure. The loss to ICICI Bank can be attributed to its exposure to Credit Default Swaps (CDS) as well as to erosion in the value of investments made by its subsidiaries in the UK and Canada. Three public sector banks, viz., State Bank of India, Bank of Baroda and Bank of India have also fallen prey to the subprime fallout.

This MTM loss has arisen out of the depreciation in the value of instruments the banks bought in the international markets. Due to rising global interest rates after the subprime crisis, the value of these securities has declined, which has forced Indian banks who have invested in these securities to provide for the difference from its profits. For ICICI Bank, the $263 mn hit on overseas credit derivative exposures has arisen because it has been selling CDS to foreign banks lending to Indian firms. CDS is an insurance product against which ICICI receives a premium. In return, the risk of the Indian company defaulting is transferred to ICICI rather than the original lender.

But as the subprime crisis deepened, liquidity dried up and CDS premia also surged, reflecting a rise in the cost of protection. And since markets are in doldrums, ICICI and other banks had to make a provision on CDS, since the premium they earned was less than the market rate. For the March 31 quarter, ICICI Bank has made a provision of around $74 mn, after having already provided $189 mn in the previous quarters. Nevertheless, such provisions may not ultimately translate into actual write-offs as there are chances that market conditions could improve by the expiry date and the value of the underlying securities could improve by then.

It is, however, undeniable that as India opens up further, Indian banks will have to gear up for more exposure to overseas risks. So, ICICI and other major Indian banks need to improve internal risk management systems and regulatory oversight. And to get the right perspective on the problems faced by the Indian banks due to credit market turmoil, its implications, and the risk control systems in Indian banks, The Analyst invited three experts—Kavita Mendonca, Forex Analyst & Derivatives Specialist, Forexserve Treasury Consultancy; Manoranjan Sharma, Chief Economist, Canara Bank; and Robin Roy, Associate Director, Performance Improvement, PricewaterhouseCoopers Pvt. Ltd.—to share their views.

The Analyst Magazine, Indian banks, Credit Default Swaps, CDS, Public Sector Banks, International Markets, Risk Management, Forexserve Treasury Consultancy, Subprime Crisis, Economist, International Monetary Fund, IMF, Derivatives Maarkets, Credit Debt Obligation, CDO, Risk Management.