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New provision rules could pinch bank bottomlines
February, 02nd 2007

Tougher provisioning norms for banks on lending to different segments imposed by the central bank on Wednesday are bound to hurt the bottomlines of banks. This has forced bank managements to work out new strategies.

RBI on Wednesday told banks to set aside more money (as provisions) out of their profits for loans extended to non-banking housing finance companies, personal loans, capital market, credit card receivables and real estate. The standard provisions to these five segments were raised to 2% from 1% earlier. This would mean that for every Rs 100-crore loan extended to any of these sectors, banks have to set aside Rs 2 crore from their profits as provision against these loans. In future, provisions set aside by banks can be used to set off any big defaults.

Clearly, banks had been caught on the wrong foot in terms of anticipating the higher provisions on any of these segments while pricing loans. The central banks fiat may now force them to either revise the profit targets for this fiscal or to work out a strategy to boost bottomlines. What worries them more is the fact that the fiscal is drawing to a close.
Several banks are scheduled to have internal brain-storming sessions and asset-liability committee meetings to finalise their strategies to counter the new policy stance on provisioning.

While some of the state-owned bank chiefs said that it may be difficult to raise lending rates from the current level of 11.30-13.75%, there would be little choice but to resort to a hike in order to protect their bottomlines. The dilemma is that higher provisions are only for some specific sectors. It would not be fair to raise rates across sectors. Therefore, we need to have different prime lending rates (PLR) linked to different sectors, said MV Nair, chairman and managing director of Union Bank of India.

Alternatively, some banks are thinking of inserting a caveat in their loan documents that allows them to tinker with the rates whenever the prudential norms are revised. We had tried something like this in the past when the government gave tax concession on interest rates for loans extended to the infrastructure sector under Section 10 (23) G. The clause said that the discount on the interest rate would be withdrawn if the government decides to recall tax concessions, said Jitendra Balakrishnan, deputy managing director of IDBI Bank. He indicated that loan documents on similar lines could be structured for taking into account changes in prudential norms.

However, sector-wise PLRs and a caveat in loan documents can only be from the prospective effect. Bankers are worried about the higher provisioning on the existing loans. The provisioning of 2% could be well above Rs 8,000 crore on a conservative basis, considering that exposure of banks to credit card receivables, personal loans, capital markets and property developers was Rs 4,13,085 crore as in March 2006.

The estimated provision of Rs 8,000 crore does not include the exposure to NBFCs where the provision has been raised to 2% from 0.40% and the revised capital market guidelines that include exposure to venture capital.

Therefore, the best way out is to see if there is any possibility of repricing the existing loans extended to these sectors, said KR Kamath, executive director of Bank of India. RBI perceives risk in these sector because they are growing very fast and there is a possibility of adverse selection of loans. Thus, the regulator is discouraging banks to giving them loans, said Mr Nair from Union Bank.

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