RBI might ask banks to make more provisions for bad loans

In case the Reserve Bank of India issue instructions to the Indian banks to keep more funds as a cushion to cover losses occurring in view of loans extended to builders and also make more provisions related to bad loans.

Therefore banks will require setting aside 1% of a loan given to commercial real estate as a provision, which will be more from the present 0.4%. RBI governor D Subbarao has classified such loans, loans given to builders for construction of commercial properties like offices, malls, entertainment zones and hotels.

OP Bhatt, chairman, State Bank of India, pointed out that there will be marginal increase in interest rates of such loans. Most of the banks are giving loans to the builders at prime lending rate (PLR) or at a spread over the PLR.

According to Chanda Kochhar, CEO of ICICI Bank, “There is no issue of asset bubble as such. The provisioning of loans extended to commercial real estate was high previously. Subsequently, the credit flow to this sector fell, which impacted its activity. Now that the activity has picked up in this sector, RBI has raised provisioning requirement back to the old levels. But banks’ exposure towards commercial real estate sector is low. NBFCs and mutual funds are more active in this space.”

Earlier after the collapse of Lehman Brothers the credit lines across banks (globally) were freeze thus the provisioning for such loans was cut down from 1% to 0.4%.

RBI stated the increase in flow of credit in this sector and the restructuring of loans is mainly responsible for the increase in provisioning of such loans. M Narendra, executive director, Bank of India said, “Excess of credit to a particular sector is a concern for RBI, and thus, provisioning has been raised. This will reduce easy access to money (for builders). Hopefully, it should result in builders lowering the price of property, something most have refrained from doing so far”.

Moreover banks have been instructed to recover the provision coverage ratio (PCR) on bad loans to 70%. As all the banks follow asset classification norms, this range between 10% for sub-standard to 100% on loss loan and PCR is the overall provision on bad loans. Thus the banks will be expected to give up PCR amount from a loan in case they have to set aside that loan account. While after holding a meeting with RBI Mr Bhatt said, banks have put forward their request before the regulator to review the entire model of asset classification. While speaking to the media, he gave indication that banks might get more than one year time to adhere to the 70% norm.

However among banks, SBI’s PCR stands to 38% and ICICI Bank’s is 55% as of March 2009, while PNB’s PCR stood at 90%. Early this year, RBI had sent a paper to SBI in which it has asked the bank to raise its PCR to the industry average of 52%. But a lower PCR do not mean the bank has not made adequate provision.