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India Equity Research Reports, IPO and Stock News
Visit http://indiaer.blogspot.com/ for complete details �� ��
http://www.kotaksecurities.com/pdf/indiadaily/indiadaily02042012.pdf
Banks/Financial Institutions
India
A new beginning, but are we ready? The RBI move to introduce dynamic provisions
(DP) is likely to reduce volatility as banks use excess provisions they made during
“periods of plenty.”RBI estimates a loan-loss provision (LLP) of 140 bps (as most banks
have yet to develop strong models) is conservative, above historical trends, indicating
high provisions in the medium term. While the intent is good we find the calculations
are from few banks, limited data, subjective and utilization-restrictive.
Towards a new beginning of less volatile returns
In what seems to be the last leg of major reforms, the RBI is seeking to move banks to reduce
earnings volatility across cycles through the implementation of dynamic provisions (DP), which will
allow banks to draw on excess provisions made during strong growth periods. The provisions
would act as a counter-cyclical buffer, reducing earnings volatility during downturns and ensuring
credit flow without serious disruptions. With the possible implementation of IFRS, volatility arising
from MTM would also be addressed. Combined with Basel 3 guidelines, we believe the major draft
proposals from the RBI are in the public domain and Indian banks should be able to transition
quite smoothly, though we expect high provisions in the interim.
Dynamic provisions to replace other provisions; specific provisioning policy to continue
The RBI is looking to remove general, floating and counter-cyclical provisions, which is ad hoc to a
more scientific approach. DP factors (1) probability of default (PD) (2) duration of loans and (3) loss
given default (LGD) in general and/or downturns on portfolios to arrive at total provisions (TP).
Existing specific provisions for NPLs are unlikely to be tinkered with. TP to be made during a year
would be a combination of DP and specific provisions. There would be a floor and a ceiling to the
total provisions created or withdrawn. Banks with a disproportionate share of corporate NPLs are
likely to benefit more than those with non-housing retail portfolios.
New provisions indicate LLP will reach 140 bps; specific provisions likely to reach 70% of NPLs
The impact on LLP is likely to be 140 bps, as recommended by the RBI, which is significantly ahead
of 90 bps reported by banks since FY2005. We expect RoA and RoEs to remain subdued (clarity to
emerge as we get the total provisions and strength of MIS with individual banks) until banks start
building models that suit their credit underwriting. While specific provisions are likely to keep
overall LLP for banks at about 120 bps, we believe the new proposal will result in keeping overall
LLP at elevated levels in the medium term, extending well beyond FY2015-16. Existing general,
floating and counter-cyclical provisions will be transferred to dynamic provisions during the
transition. Banks with no historical data should make provisions based on peak loss-given default
(LGD), which is negative, in our view, as most banks would fall in this category.
Proposal without historical data is a concern; expect modification over time
The proposal, along with Basel 3 capital, aim to address systemic risk emerging from the banking
sector, but the methodology adopted is extremely subjective, main for the following reasons:
(1) the period under consideration is less than 10 years and we have witnessed incomplete cycles
in such a time span; (2) loans covered in this period are not a complete data set and have been
primarily taken from few banks; (3) the RBI has not been able to properly collate LGD, and has
arrived at it on bases such as the “expert judgment of bank officials”; (4) arguments for
introducing the proposal are weak as they don’t seem to be backed by strong data for the overall
sector; (5) banks have only recently been asked to implement a stronger MIS to improve
monitoring and forecasting; (6) use of dynamic provisions is severely restricted as they require RBI
approval.
India Equity Research Reports, IPO and Stock News
Visit http://indiaer.blogspot.com/ for complete details �� ��
http://www.kotaksecurities.com/pdf/indiadaily/indiadaily02042012.pdf
Banks/Financial Institutions
India
A new beginning, but are we ready? The RBI move to introduce dynamic provisions
(DP) is likely to reduce volatility as banks use excess provisions they made during
“periods of plenty.”RBI estimates a loan-loss provision (LLP) of 140 bps (as most banks
have yet to develop strong models) is conservative, above historical trends, indicating
high provisions in the medium term. While the intent is good we find the calculations
are from few banks, limited data, subjective and utilization-restrictive.
Towards a new beginning of less volatile returns
In what seems to be the last leg of major reforms, the RBI is seeking to move banks to reduce
earnings volatility across cycles through the implementation of dynamic provisions (DP), which will
allow banks to draw on excess provisions made during strong growth periods. The provisions
would act as a counter-cyclical buffer, reducing earnings volatility during downturns and ensuring
credit flow without serious disruptions. With the possible implementation of IFRS, volatility arising
from MTM would also be addressed. Combined with Basel 3 guidelines, we believe the major draft
proposals from the RBI are in the public domain and Indian banks should be able to transition
quite smoothly, though we expect high provisions in the interim.
Dynamic provisions to replace other provisions; specific provisioning policy to continue
The RBI is looking to remove general, floating and counter-cyclical provisions, which is ad hoc to a
more scientific approach. DP factors (1) probability of default (PD) (2) duration of loans and (3) loss
given default (LGD) in general and/or downturns on portfolios to arrive at total provisions (TP).
Existing specific provisions for NPLs are unlikely to be tinkered with. TP to be made during a year
would be a combination of DP and specific provisions. There would be a floor and a ceiling to the
total provisions created or withdrawn. Banks with a disproportionate share of corporate NPLs are
likely to benefit more than those with non-housing retail portfolios.
New provisions indicate LLP will reach 140 bps; specific provisions likely to reach 70% of NPLs
The impact on LLP is likely to be 140 bps, as recommended by the RBI, which is significantly ahead
of 90 bps reported by banks since FY2005. We expect RoA and RoEs to remain subdued (clarity to
emerge as we get the total provisions and strength of MIS with individual banks) until banks start
building models that suit their credit underwriting. While specific provisions are likely to keep
overall LLP for banks at about 120 bps, we believe the new proposal will result in keeping overall
LLP at elevated levels in the medium term, extending well beyond FY2015-16. Existing general,
floating and counter-cyclical provisions will be transferred to dynamic provisions during the
transition. Banks with no historical data should make provisions based on peak loss-given default
(LGD), which is negative, in our view, as most banks would fall in this category.
Proposal without historical data is a concern; expect modification over time
The proposal, along with Basel 3 capital, aim to address systemic risk emerging from the banking
sector, but the methodology adopted is extremely subjective, main for the following reasons:
(1) the period under consideration is less than 10 years and we have witnessed incomplete cycles
in such a time span; (2) loans covered in this period are not a complete data set and have been
primarily taken from few banks; (3) the RBI has not been able to properly collate LGD, and has
arrived at it on bases such as the “expert judgment of bank officials”; (4) arguments for
introducing the proposal are weak as they don’t seem to be backed by strong data for the overall
sector; (5) banks have only recently been asked to implement a stronger MIS to improve
monitoring and forecasting; (6) use of dynamic provisions is severely restricted as they require RBI
approval.
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