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Indian Banks Have Manageable Exposure To Contagion And Unrecognized Losses

Indian banks and rated finance companies can endure potential contagion effects from the demise of Silicon Valley Bank (SVB) and UBS's hasty takeover of Credit Suisse AG. The Indian institutions have no meaningful direct exposure to SVB, Signature Bank, and Credit Suisse. S&P Global Ratings expects the secondary impacts to be manageable, although the decision to write-off Credit Suisse's additional Tier 1 bonds may contribute to a higher cost of capital for banks. Only a significant escalation would lead us to change our view.

Funding profiles have generally been a strength for Indian banks. Funding is predominantly in the form of customer deposits, a large proportion of which are from households.

Support for deposit franchises comes from the banks' wide branch networks, sizable retail customer base, and deposit insurance for small savers of up to Indian rupee (INR) 500,000 for deposits with individual banks. India's high domestic savings rate offers further support, in our view. Moreover, about 60% of the banking system is government-owned, bolstering the perceived safety of bank deposits.

In contrast, finance companies are reliant on wholesale funding, which is confidence sensitive. But finance companies rated by S&P Global Ratings have access to multiple sources of funding and limited concentration. Also, they have a sizable proportion of bank borrowings, spread across various banks, including those that are government-owned, and this tends to stabilize funding profiles.

Group Benefits

Some finance companies such as Bajaj Finance Ltd. and Hero FinCorp Ltd. also benefit from being part of a stronger group, and consequently have better or preferential access to funds.

Others such as Muthoot Finance Ltd. and Manappuram Finance Ltd. face refinancing risk because of their dependence on sizable short-term liabilities, and this is already reflected in our moderate assessment of funding for both these entities. Mitigating factors include positive asset-liability management. This stems from the fact that a large portion of their assets are short-term gold loans, which are self-liquidating, and are a constant source of liquidity. Moreover, Muthoot Finance and Manappuram Finance also have a high level of equity capital, at just over a quarter of their total liabilities.

Shriram Finance Ltd. is also strongly reliant on confidence-sensitive wholesale funding sources such as securitization, which could lead to higher volatility in funding costs.

Risk Of Unrecognized Losses Is Under Control

The risk of unrecognized losses hitting banks' balance sheets is manageable, in our view. Indian banks generally hold high levels of government securities due to a steep statutory liquid ratio requirement.

For example, 20%-25% of assets for large government-owned banks and 17%-19% of assets of top private sector banks are parked in government securities. In addition, about 80% of these government securities are in held-to-maturity portfolios (see chart 1). This exposes them to the risk of unrecognized losses if interest rates rise.

Chart 1


Low Duration, Retail-Funded, And Improved Capital Provide Buffer

We view the risks of unrecognized losses to be manageable for the following reasons:

Movement in Indian government securities has not been as sharp as in the case of U.S. Treasuries.  Policy rate hikes in India versus the U.S. from COVID-lows have been relatively lower. For example, in India, the policy rates of 6.5% is only marginally higher than pre-COVID levels, though the interest rates dropped to 4% during the pandemic. In the U.S., on the other hand, the federal funds rate rose to about 4.5%, from 0.1% at end 2021.

The risk of significant unrealized losses materializing on a portfolio of high-quality liquid securities is typically contained for the banks we rate globally.   However, it could be triggered for some banks with concentrated business models, or with more vulnerable funding or liquidity profiles, including more aggressive asset/liability management practices.

We view these risks as limited for Indian banks. They are not overtly dependent on wholesale funding, are primarily funded by retail deposits, and have sufficient liquidity since most of their investments tend to be in government securities.

Chart 2


Modified duration is low.  For large banks where data is available, the modified duration for the available-for-sale (AFS) book as of Dec. 31, 2022, generally ranged between 1.1 and 2.7. For the held-to-maturity (HTM) book the modified duration should be higher. For example, Bank of Baroda's modified duration on the AFS book is 1.79 whereas that of the held-to-maturity (HTM) book is 4.95.

Credit risk in investment portfolios is also limited.  Corporate bond portfolios are small and often include relatively stronger Indian companies.

Banks' capital has improved in recent years.  The capital to-risk weighted assets ratio (CRAR) was about 16% as of Sept. 30, 2022, which helps to absorb these losses if they materialize. As per data from the central bank, in a stress scenario, if there is a parallel upward shift of the yield curve of 250-basis point (bps), the impact on the banks' government securities classified as HTM, if marked to market, would cause the system level CRAR to decrease by 307 bps. And the hit on held-for-trading (HFT)/AFS book would be about 80 bps, with foreign banks operating in India the most exposed. The impact on private sector banks' AFS/HFT is limited to 34 bps. The actual interest rate hike since September 2022 is only 50 bps.

A study by the Reserve Bank of India shows that, in the case of the HTM book, the unrealized loss is bigger for government-owned banks that we see as having a high likelihood of government support, if required.

Chart 3


The investment book of rated finance companies is much smaller.  These entities tend to hold their liquid assets in the form of cash and bank balances; only about 3% of their assets are in government securities, which is often related to statutory liquid ration requirement for the public deposits they hold. Hence, we expect the proportion of unrealized losses to be low.

It's too soon to assess the full impact of the SVB and Credit Suisse fallout, but low duration, strong funding profiles and adequate capital suggests the effect should be limited. We have yet to see any tail risk manifesting. Foreseeable secondary effects could include increasing risk aversion by investors. This ultimately could result in higher funding costs or other negative consequences.

Editor: Lex Hall

Related Research

This report does not constitute a rating action.

Primary Credit Analysts:Deepali V Seth Chhabria, Mumbai + 912233424186;
Geeta Chugh, Mumbai + 912233421910;
Amit Pandey, Singapore + 65 6239 6344;
Nikita Anand, Singapore + 65 6216 1050;
Shinoy Varghese, Singapore +65 6597-6247;
Secondary Contact:Ruchika Malhotra, Singapore + 65 6239 6362;

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