Are India's banks facing an asset-quality shock?

Article By HARSH JOSHI on Wall Street Journal. Click Here to read the original article.

The country's banks have often been praised for their conservatism, but there is creeping evidence that raises questions about the quality of their loans.
Real estate isn't the only area of risks, though that sector has shone an unflattering light on banks' riskier lending practices.

India's three biggest airlines, for example, owe nearly $10 billion to banks, and lenders already have been forced to restructure some of this debt because of the global financial crisis and were unable to repay. Kingfisher Airlines and flagship Air India continue to lose money.

There's also the more recent lending spree to India's telecommunications companies after they spent $23 billion on new airwaves. Banks don't disclose this debt, but even before the third-generation wireless licenses were financed during this fiscal year, telecom loans were 2% of lenders' total loan books at the end of March, Goldman Sachs estimates.

Now, this industry faces challenges due to allegations of corruption when the companies were granted licenses by the telecom ministry in 2008. If some of these licenses are canceled or the companies are ordered to pay higher rates, it could force some of them to delay repayments to the banks.

Then there is the outstanding credit to the microfinance industry. These institutions, which offer small-ticket loans mostly to farmers and low-paid workers in India's deep interiors, are accused of charging exorbitant interest rates, thanks to lax regulation. Now, political pressure means provincial governments and New Delhi may be quick to crack down hard.

If the microlenders face defaults from individual borrowers, some of it in turn will hit banks. At ICICI, for example, where microfinance loans make up 1.2% of the total lending, 10% of these going bad would impact profit before taxes by 2.4%, Citi Investment Research says.

Real estate remains an old culprit. Banks have more than $22 billion loans outstanding with the real-estate sector, mostly to small-scale developers, as of the end of September.

Banks are being prudent in some ways. Outstanding credit-card loans, for example, were down 7.4% in September from a year earlier.

It's unclear at this stage to what extent these risks will harm the credit and asset quality of these banks. It will be good for the financial sector, and investors, if India's big banks come clean on their books.