Case analysis: Risk management by Indian banks
The banking and financial crises in recent years in emerging economies have demonstrated that, when things go wrong with the financial system, they can result in a severe economic downturn. From this perspective, financial sector reforms are essential in order to avoid such costs. These reforms have become the tools for banks to manage risk. Some of the tools are:
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1) Interest Rate Scenario
The first important issue that I would like to highlight relates to interest rates. Interest rates reflect strongly to inflation rates, there has been a distinct downward drift in the inflation rate during the second half of the 1990s, which is now at around half the level as compared with the first half of the 1990s. Both the popular measures of inflation – the Wholesale Price Index (WPI) and the Consumer Price Index (CPI) – have shown a definite fall in the recent period. This is clearly reflected in the downward trend in nominal interest rates.
The banks have also reduced their deposit rates. But the lending rates of banks have not come down as much. While banks have reduced their prime lending rates (PLRs) to some extent and are also extending sub-PLR loans and effective lending rates continue to remain high (Table 1 and Chart 1).
2) Lending to Small and Medium Enterprises
Banks have now understood the problems with lending large organizations. The large organization not only reduces the interest rates by bargaining but also makes default payments by which banks are under tremendous risk, and hence banks are now making a move to provide more loans to small and medium enterprises.
3) Revival of Long-Term Financing
The development finance institutions (DFIs) were set up in the 1950s to provide medium and long-term finance to the private sector. Many of these institutions were sponsored by the Government. DFIs were expected to resolve long-term credit shortages and to acquire and disseminate skills necessary to assess projects and banks creditworthiness. The current trend is of DFIs converting themselves into banks. In this context, the future of long-term lending acquires great importance.
4) Non-Performing Assets
As of March 31, 2002, the gross NPAs of scheduled commercial banks stood at Rs.71,000 crore, of which the NPAs of public sector banks constituted Rs.57,000 crore. The absolute amount of NPAs continues to be a major drag on the performance of banks. Banks uses the process of securitisation of assets to remove NPAs from the balance sheets.
5) Investing in government securities:
In the current interest rate environment, banks are finding it more profitable to invest in government securities. In 2001-02, trading profits of public sector banks more than doubled to Rs.5,999 crore from Rs.2,250 crore in 2000-01. The net profits of these banks during these two years were Rs.4,317 crore and Rs.8,301 crore respectively and this includes an additional Rs.1,365 crore and Rs.1,547 crore from forex operations. The Reserve Bank has been encouraging banks to be proactive in risk management and banks have been directed to maintain a certain level of Investment Fluctuation Reserve (IFR).
TABLE 1 : REAL INTEREST RATES
Year
Weighted
Weighted
Average
Average
Inflation Rate
Real Interest Rate
Ended
Average
Average
Cost of
Cost of
WPI
Manufact-
CPI-IW
Borrowers
Central
Depositors
March
Lending
Interest Rate
Aggregate
Time
uring Price
Government
Rate of
of Central
Deposits
Deposits
SCBs
Government
of SCBs
of SCBs
Securities
1
2
3
4
5
6
7
8
9=(2-7)
10=(3-6)
11=(5-8)
1990-91
15.0
11.4
8.1
10.6
10.3
8.4
4.6
6.6
1.1
6.0
1991-92
16.5
11.8
7.1
9.1
13.7
11.3
13.5
5.2
-1.9
-4.4
1992-93
16.8
12.5
7.7
9.6
10.1
10.9
9.6
5.9
2.4
0.0
1993-94
16.5
12.6
6.9
8.7
8.4
7.8
7.5
8.7
4.2
1.2
1994-95
16.1
11.9
6.4
7.0
12.5
12.2
10.1
3.9
-0.6
-3.1
1995-96
17.1
13.8
6.9
8.5
8.1
8.6
10.2
8.5
5.7
-1.7
1996-97
16.9
13.7
7.6
9.4
4.6
2.1
9.4
14.8
9.1
0.0
1997-98
16.3
12.0
7.3
8.8
4.4
2.9
6.8
13.4
7.6
2.0
1998-99
15.5
11.9
7.4
8.9
5.9
4.4
13.1
11.1
6.0
-4.2
1999-00
15.0
11.8
7.1
8.6
3.3
2.7
3.4
12.3
8.5
5.2
2000-01
14.3
11.0
6.8
8.1
7.2
3.3
3.8
11.0
3.8
4.3
2001-02
13.9
9.4
7.0*
8.3*
3.6
1.8
4.3
12.1
5.8
4.0
Average
1990-91
to 1995-96
16.3
12.3
7.2
8.9
10.5
9.9
10.4
6.5
1.8
-0.3
1996-97
to 2001-02
15.3
11.6
7.2
8.7
4.8
2.9
6.8
12.5
6.8
1.9
Table 2 : Comparative Position of International Real Interest Rates
Country /
Money
Long-term
Prime Rate
Inflation Rate
GDP Growth
Period Average
Market Rate
G-sec Yield
United States
1991 to 1996
1.50
3.71
4.40
3.09
2.58
1997 to 2001
2.73
3.20
5.73
2.46
3.37
United Kingdom
1991 to 1996
4.05
5.30
4.25
3.25
1.92
1997 to 2001
3.40
2.77
3.46
2.57
2.76
Germany
1991 to 1996
3.63
4.09
9.04
2.85
3.20
1997 to 2001
1.99
3.17
7.75
1.57
1.75
Japan
1991 to 1996
2.00
2.78
3.57
1.16
1.74
1997 to 2001
0.09
1.40
2.07
0.13
0.69
Korea
1991 to 1996
7.50
7.21
3.16
5.99
7.35
1997 to 2001
4.79
5.85
6.74
3.82
4.31
Thailand
1991 to 1996
3.71
5.78
7.74
4.97
8.17
1997 to 2001
3.22
4.65
6.98
3.44
-0.20
China
1991 to 1996
N.A.
N.A.
-2.09
12.32
11.61
1997 to 2001
N.A.
N.A.
6.28
0.23
7.93
India
1991 to 1996
3.43
N.A.
6.57
10.52
5.41
1997 to 2001
3.40
5.87
7.62
5.08
6.14
Hungary
1991 to 1996
N.A.
N.A.
5.11
25.04
-1.63
1997 to 2001
N.A.
N.A.
4.13
12.29
4.52
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