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Key macro-economic, regulatory and industry issues p4/NPA lifecycle in banks and role
of early warning systems (EWSs) to mitigate credit risks p13/Role of CRA in credit risk
assessment and its impact in terms of information value p16/Feasibility of an umbrella
regulator p21/Regulatory role for improving efficacy of CRAs p23/ Conclusion p26
www.pwc.in
Message
Message
R Gandhi
Deputy Governor, RBI
Message
Non-performing assets (NPAs) are a key concern for banks
in India. They are the best indicator of the health of the
banking industry. Public sector banks have displayed
excellent performance and have beaten the performance of
private sector banks in financial operations. However, the
only problem of these banks is the increasing level of nonperforming assets, year by year. On the contrary, the NPAs
of private sector banks have shown a decline. A reduction
in NPAs shows that banks have strengthened their credit
appraisal processes over the years. The increase in NPAs shows
the necessity of provisions, which bring down the overall
profitability of banks. Therefore to improve the efficiency and
profitability of banks, NPAs need to be reduced and controlled.
A high degree of NPAs suggests high probability of a large
number of credit defaults that affect the profitability and
liquidity of banks. Under the circumstances, the role of credit
rating agencies also needs to be relooked at and brainstormed
over. We need to devise a way forward to ensure that rating
agencies put forth an improved mechanism to keep a check.
The broad issues facing the modern day banking sector
have been exhaustively covered in our report prepared
in close association with our knowledge partner
PricewaterhouseCoopers India Pvt Ltd. The PwC team has done
full justice with the topic and I am sure the deliberations in
the conference will throw light on the strategies to counter the
issues affecting the bottom-line.
I wish the conference success.
D. S. Rawat
Secretary General , ASSOCHAM
Munesh Khanna
Executive Director, Financial Advisory Services
Pricewaterhouse Coopers Pvt Ltd
PwC
30.8%
28.1%
22.3%
21.5%
17.5%
7.0%
FY05
9.5%
FY06
9.6%
FY07
9.3%
FY08
6.7%
FY09
GDP
Source: Reserve Bank of India
17.0%
16.9%
8.4%
FY10
Credit growth
8.4%
FY11
6.5%
FY12
15.1%
4.8%
FY13
7.0%
5.4%
FY03
6.5%
5.2%
3.9%
FY02
8.4%
6.7%
4.5%
3.3%
FY01
9.3%
8.4%
8.0%
7.2%
4.2%
9.6%
9.5%
FY04
FY05
FY06
2.5%
FY07
FY08
GDP
2.2%
2.3%
FY09
FY10
2.5%
2.4%
FY11
3.1%
FY12
FY13
4.9%
4.5%
3.6%
FY14E
GNPA
27.9
27.9
FY05
23.2
18.0
6.0
16.8
16.6
15.1
(1.2)
(13.9)
FY06
40.2
21.3
11.5
(8.4)
54.1
54.0
43.2
FY07
FY08
FY09
FY10
FY11
FY12
FY13
9.2
5.7
2.5
1.0
FY06
2.4
2.5
2.5
1.0
1.1
1.1
FY07
7.6
6.7
FY08
5.8
2.4
1.1
FY09
GNPA (%)
NNPA (%)
2.2
1.7
1.4
FY10
4.2
3.4
2.9
FY11
FY12
FY13
GNPA + RA (%)
Source: Reserve Bank of India and Goldman Sachs Global Investment Research
The total banking credit outstanding as on 31 March 2013 was 57.90 trillion INR.
Of this, the stressed asset (GNPA + RA) size is 5.91 trillion INR (10.2% of total)
This can be further broken down into GNPA of 2.43 trillion INR (4.2%) and RA of 3.47 trillion INR (6.0%)
The biggest contributor to the 10.2% pool of GNPA is state-owned banks, where the stressed asset ratios (SA/total advances)
in some cases are already high percentages.
Stressed assets as a percentage of total advances
20
16.4
PSU banks
15
10
5
0.5
0
10.1
Private banks
YES
1.3
HDBK
1.4
INBK
2.1
KTKM
3.7
3.0
INGV
AXIS
FY13
PwC
9.4
9.5
11.1
5.3
ICBK
Q2FY14
FED
SBI
BOB
OBC
PNB
93.7%
89.4%
90.2%
77.2%
76.8%
70.9%
70.4%
65.8%
56.2%
37.7%
FY02
FY03
FY04
FY05
51.5% 52.1%
46.3%
FY06
39.5%
39.3%
34.4%
32.2%
26.4%
FY07
All banks
FY08
FY09
FY10
71.4%
59.2%
46.3%
FY11
FY12
FY13
PSU banks
FY13 GNPA
2.1%
2.1%
4.7%
4.1%
3.4%
1.8%
3.7%
1.8%
Agriculture
Industry
Services
Retail
Agriculture
Industry
Services
Retail
17.4%
15.6%
14.0%
15.0%
9.0%
8.0%
4.5%
4.7%
Aviation
4.0%
1.8%
1.0%
Textiles
Power
Infrastructure
FY09
Telecom
1.0% 2.0%
Mining
Real estate
FY13
Macro-economic,
regulatory and industry
issues impacting SAs
0%
0%
16%
15%
17%
PwC
21%
13%
15%
FY10
FY11
-2%
6%
-3%
2%
-12%
-29%
Macro-economic risks
Pre-2008, the positive market
sentiment and buoyancy in the
economy led to huge capacity build-up
by Indian corporates, primarily funded
by debt.
19%
19%
FY05
FY06
FY07
FY08
FY09
FY12
FY13
11.44%
9.48%
6.72%
7.05%
4.17%
FY05
9.57%
9.32%
7.87%
8.03%
8.59%
8.82%
8.91%
8.65%
4.57%
FY06
FY07
FY08
FY09
6.70%
6.69%
6.72%
FY10
FY11
FY12
4.47%
4.86%
FY13
FY14
CPI
25.0%
2.00
20.0%
1.50
15.0%
1.00
10.0%
0.50
5.0%
0.00
0.0%
RoE (%)
Asset turnover
Source: Jefferies
816
800
732
120.0
100.0
700
80.0
600
444
500
60.0
400
276
300
200
100
60
48
30
30
FY05
FY06
FY07
FY08
40.0
228
204
20.0
84
FY03
FY04
10 PwC
FY09
FY10
FY11
Number of cases
FY12
FY13
40.6%
25.7%
27.1%
33.7%
46.0%
62.2%
21.5%
28.0%
32.6%
30.7%
20.2%
28.7%
33.8%
33.7%
FY09
FY10
FY11
23.5%
52.8%
44.9%
14.3%
FY08
Distress
Grey
FY12
FY13
Saf e
Source: Jefferies Performed on 414 companies out of the BSE 500 Index, making up almost 40% of the total banking system loans
17.4%
14.0%
15.6%
15.0%
9.0%
8.0%
4.5%
4.7%
4.0%
1.8%
1.0%
Aviation
Textiles
Power
Inf rastructure
FY09
Telecom
Mining
1.0% 2.0%
Real estate
FY13
11
Industry risks
In addition to the macro-economic factors, there are
industry-specific reasons that cause a rise in SA levels in
India. Sectors which are seeing increased stress are aviation,
textile and telecom among others.
12 PwC
NPA
Identification of default
borrowers
Classification of NPAs
Record of recovery monitoring
Assessment of collaterals and
degree of credit weakness
Measure
Consolidate and apply
income recognition
policy
Execute write offs and
appropriation of P&L
Regulatory reporting
Management reporting
Identification
Insight
Forecasting
Business activity
monitoring/alerting
Investigation of intent
and business rational of
default borrowers
Policy and process
Review
NPAs
Stressed assets
Me
a
gation
e s ti
Inv
su
re
Crisis management
Takeover of assets
Cash flow management
Interim management
Turnaround planning and
implementation
Cr i s i s m g m t
Regulatory
framework
so
lu t
ht
sig
ev
In
Re
Revitalise
Implement CAP for stressed
assets
Restructuring of NPAs
Sale or divesture of business
Application of new equity fund
Change management
NPA lifecycle
management
it a li s e
io n
Key enablers:
Internal policies
Business models
Technology
Process
13
Financial components/periodicity
Overdue frequency
Changes in management
Asset class
Standard
Watch list
14 PwC
Operational
Attitude of borrowers
Information about
borrower initiating the
process of winding up or
not doing the business
Overdue receivables
External non-controllable factor like natural
calamities in the city
where borrower conduct
his business
Others
Changes in government
policies
Death of borrower
Competition in the market
Frequent changes in
plan and nonpayment of
wages
15
16 PwC
Banks can also use credit rating for loans to conserve capital as illustrated below.
Rating
Basel I
Risk weight
Risk weight
AAA
100%
90
20%
18
72
AA
100%
90
30%
27
63
100%
90
50%
45
45
BBB
100%
90
100%
90
BB and below
100%
90
150%
135
(45)
Unrated
100%
90
100%
90
17
Financial markets may process information rather than CRAs in the following manner:
Financial markets
CRAs
Markets may process information faster, leading to overreaction, inherent volatility and mispricing
Markets have more traders and noise. Markets are also known to
overreact, especially to short-term noise
Long-term bond investors generallybuy and hold longer. Need not react
immediately if long-term prospects are not endangered
18 PwC
19
Regulatory concerns
SEBI in Report of the Committee on
Comprehensive Regulation for Credit
Rating Agencies(2009) indicated
the following as potentially the major
regulatory concerns of the Indian
regulators.
1. Regulatory arbitrage resulting
from activities of the CRAs being
governed or used by various
regulators.
2. Inadequacy of existing
methodologies adopted by CRAs
for structured products given their
complexity, multiple tranches
and their susceptibility to rapid,
multiple-notch downgrades which
are pro-cyclical.
3. A basic conflict of interest which is
partly inherent, since the sponsor
orissuer of new instruments pays
the CRA for being rated.
4. A general lack of accountability as
CRAs do not have a legal duty of
accuracy and are often protected
from liability in case of inaccurate
ratings.
20 PwC
Type of instrument
Regulator
Bank loans
RBI
Commercial paper
RBI
RBI
RBI
Security receipts
RBI
SEBI
IPO grading
SEBI
SEBI
SEBI
10
11
Maritime grading
Directorate General of
Shipping
Regulator
IRDA
Government of India
RBI
Feasibility of an umbrella
regulator model
The multiplicity of regulators has
necessitated the need for interregulatory co-ordination. It has become
necessary for policy makers to look at
the fact that there are apprehensions
about regulatory arbitrage taking
advantage of lack of co-ordination
among various regulators. Policy
makers need to identify areas where
they could facilitate an optimal
environment for removal of asymmetric
information. It relates to the design,
structure and extent of the regulatory
structure pertaining to the operations
of CRAs, and an enquiry as to whether
the prevailing policy regulatory
regime has helped or harmed
their functioning.
21
22 PwC
23
24 PwC
2.
3.
4.
Compulsory separation of
advisory services into separate
companies: Currently, as per
regulations, a CRA cannot offer
fee-based services to the rated
entities, beyond credit ratings
and research. The regulations
also mandate that a credit rating
agency shall maintain an arms
length relationship between its
credit rating activity or any other
activity. However, CRAs have
floated subsidiary companies
for undertaking other activities
such as consulting, software
development, knowledge process
outsourcing, research, etc. CRISIL
and ICRA, the leading players
have separated the advisory
business into separate companies,
managed by separate teams with
separate organisation structures.
However, with the proposed
umbrella regulator, the conflict
of interest of the CRAs with their
subsidiaries can be looked into
from a regulatory arbitrage point
of view. Also, the CRAs must
disclose all details of conflict of
interest which impact their job of
ratings.
5.
6.
25
Conclusion
In the last couple of years, as Indian
economy witnessed downturn trends,
the banks have been straddled with
high NPAs and restructured assets.
Macro-economic dynamics may be
a major contributor, however we
also believe that inadequate credit
assessments and monitoring during
the upturn in the economy has
also contributed to the same. All
participants in the ecosystem, the
banks, regulators, borrowers and CRAs
need to take responsibility.
Our view is while we cannot undo
the mistakes or errors that have
been committed in terms of credit
assessment and monitoring, effective
steps needs to be taken and a holistic
approach is the best way forward. All
stakeholders in the ecosystem need to
proactively contribute towards a better
credit assessment and monitoring
framework with the regulator enabling
such initiatives.
Some of our major recommendations
include the following:
Effective use of early warning
systems as the monitoring
mechanism by the banks to
proactively detect and resolve
issues related to the credit risk of
the borrower. For the resolution of
NPAs, an end to end NPA lifecycle
management can also help.
To create a holistic regulatory
framework for credit ratings along
with an umbrella regulator.
To minimise the opportunity of
regulatory arbitrage
26 PwC
Glossary
Term
Meaning
Percentage
Estimate
'000
Thousands
ARC
AXIS
Axis Bank
Bn
Billion
BOB
Bank of Baroda
c.
Approximate
CAGR
CDR
CPI
EBITDA
EWS
FED
Federal Bank
FY
Financial year
FYXXE
FYXXP
GCF
GDP
GNPA
HDBK
HDFC Bank
ICBK
ICICI Bank
INBK
Indian Bank
INGV
ING Vysya
INR
JLF
KTKM
LPG
Mn
Million
NA
Not available
NNPA
No.
Number
NPA
Non-performing asset
Term
Meaning
OBC
p.a.
Per annum
PAT
PNB
PSU
RA
Restructured asset
RBI
RoE
Return on equity
SA
Stressed assets
SBI
SKO
SR
Security receipts
SMA
Tn
Trillion
USD
YES
Yes Bank
YoY
Year-on-year
Improving efficacy of credit rating agencies
27
Notes
28 PwC
29
About ASSOCHAM
Acknowledgement
ASSOCHAM initiated its endeavour of value creation for Indian industry in 1920.
Having in its fold more than 400 chambers and trade associations, and serving
more than 4,00,000 members from all over India, it has witnessed upswings as well
as upheavals of the Indian economy, and has contributed significantly by playing
a catalytic role in shaping the trade, commerce and industrial environment of the
country.
Today, ASSOCHAM has emerged as the fountainhead of knowledge for Indian
industry, which is all set to redefine the dynamics of growth and development in the
technology driven cyber age of the knowledge based economy.
ASSOCHAM is seen as a forceful, proactive, forward-looking institution equipping
itself to meet the aspirations of corporate India in the new world of business. It is
working towards creating a conducive environment of Indian business to compete
globally.
ASSOCHAM derives its strength from its promoter chambers and other industry and
regional chambers and associations spread across the country
Chandan Kumar
banking@assocham.com
Vikas Kumar Mishra
corporate1@assocham.com
Md. Areeb Imam
areeb.imam@assocham.com
Md. Faheem Akhtar
faheem.akhtar@assocham.com
under the able leadership & guidance
of D S Rawat, Secretary General,
ASSOCHAM .
Vision
Empower Indian enterprise by inculcating knowledge that will be the catalyst of
growth in the barrier-less technology driven global market and help it upscale, align
and emerge as a formidable player in respective business segments.
Mission
As a representative organ of corporate India, ASSOCHAM articulates the genuine,
legitimate needs and interests of its members. Its mission is to impact the policy and
legislative environment so as to foster a balanced economic, industrial and social
development. We believe education, IT, BT, health, corporate social responsibility and
environment to be the critical success factors.
About PwC
Contacts
Munesh Khanna
Partner/Executive Director
Email: munesh.khanna@in.pwc.com
Phone: +919820142611
Robin Roy
Associate Director
Email: robin.roy@in.pwc.com
Phone: +919986261133
Ankur Jain
Senior Manager
Email: ankur.j@in.pwc.com
Phone: +919867530113
www.pwc.in
Data Classification: DC0
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estimates contained in this publication represent the judgment of PwCPL at this time and are subject to change without notice. Readers of this publication are
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2014 PricewaterhouseCoopers Private Limited. All rights reserved. In this document, PwC refers to PricewaterhouseCoopers Private Limited (a limited
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AK 202 - May 2014 Improving efficacy of credit rating agencies.indd
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