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India Banks Need Overhaul

India Banks Need OverhaulIndia Banks Need Overhaul

The International Monetary Fund said India’s record $32 billion bank-recapitalization plan must be accompanied by restructuring of state-run lenders, as the central bank warned of rising bad loans.

Under the baseline scenario in a stress test, the Indian banking sector’s gross bad-loan ratio will increase to 10.8% in March and 11.1% by September 2018, from 10.2% in September 2017, according to the Reserve Bank of India’s Financial Stability Report published late in Mumbai on Thursday. The financial system remains stable, the authority said, Bloomberg reported.

In a separate report published around the same time, the IMF said India should work toward its stated goal of consolidating its banking sector, but should avoid mergers of weak state-run banks with stronger peers.

“Exit of the weakest (small) banks should be considered, with voluntary transfer of liabilities and good assets to stronger market participants, leaving bad assets behind in liquidation,” the IMF said. “Consideration should also be given to further reducing the state’s ownership stake, including full privatization of some of the banks and access to international bond markets.”

Indian banks have some of the highest levels of debt of any emerging market, with the bulk of bad loans saddled in public-sector lending institutions.

This debt burden means that banks have been stretched too thin to lend for fresh investments, holding back growth in Asia’s third-largest economy, AFP reported.

The IMF—in its annual assessment of the stability of India’s financial system—said these conditions are testing the resilience of banks. Larger lenders appear sturdy but “the system is subject to considerable vulnerabilities”, the IMF said in its report.

In particular, a “group of public sector banks are highly vulnerable to further declines in asset quality”, it added. The IMF said despite considerable progress there was scope for improving oversight of the financial sector, including in regards to the independence of RBI.

“Notably, these include strengthening the RBI’s de jure independence as well as its powers” over the public sector banks and “expanding other financial regulators’ resources”, the IMF said.

The government has been urging the central bank to cut interest rates to encourage investment. The bank has been reluctant to do so, fearing that reducing rates—already at a seven-year low of 6%—could stoke inflation.

In May, the government gave the central bank greater powers to intervene in cases of bad loans, and to order lenders to deal with their debts under bankruptcy laws. In October it announced a $32 billion recapitalization plan for state-owned banks to help them clean up their books and revive investment as India’s $2 trillion economy slowed.

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