Indian banks may not be able to cope with unexpected losses, says International Monetary Fund

The International Monetary Fund (IMF) has warned that Indian banks don't have enough of a buffer to absorb unanticipated losses, and may have to dip into capital if credit quality deteriorates. In its global Global Financial Stability Report (GFSR) released on Wednesday, the IMF said Indian banks have not set aside enough money from profits to cover bad assets compared with others.

"Relative to regional peers, loan loss provisioning appears low in Hungary, India, Indonesia,  Malaysia, and South Africa, suggesting that any potential credit quality deterioration may need to be absorbed by equity capital,"the report said. While most countries now meet the Basel III minimum Tier 1 capital requirement of 6%, the relative provisioning has created differences in loss-absorbing capacity.

"Hungary and India have the lowest loss-absorbing buffers, followed by Chile and Russia, although buffers in these last two countries meet Basel III requirements,"the report said. Indian company earnings are exposed to exchange-rate and foreign-currency risk, implying that if the domestic currency depreciates sharply, as happens in most emerging markets,
they could face significant stress.

 "Currency depreciation in an environment of rising global uncertainties could lead to higher payments of principal and interest on foreign currency debts and thus to a further erosion of profitability,"the report said, adding that losses could be most in cases where risks are covered largely through natural hedges. "Where foreign currency liabilities are largely hedged through natural hedges, foreign exchange losses could amount to 20-30 per cent of earnings in India, Indonesia, and Turkey,"it warned, calling for assessing the effectiveness of natural hedges as well.