The central bank has reported that the loan exposure of commercial banks to real estate and housing is still a high level risk.

If a quarter of current loans to the realty sector were to be directly downgraded to loss, capital adequacy ration (CAR) of 11 banks – out of 31 banks – would sink below the required level of 10 per cent, according to the latest Financial Stability Report of the central bank.

The capital adequacy ratio is the ratio of a bank’s core capital to its risk
asset. Banks and financial institutions ability to endure shocks is tested by their capital adequacy ration.

Likewise, commercial banks have lent some Rs 60.56 billion to the real estate sector as of first seven months of the current fiscal year 2013-14.

The report further stated that a standard credit shock would push the capital adequacy ration of 27 banks – out of the 31 commercial banks – below the regulatory minimum of 10 per cent in mid-July 2013. The number of such vulnerable banks stood at 22 in mid-July 2012 and increased to 28 in mid-January 2013.

In the event of two large loans being downgraded from the performing to the substandard category, the capital adequacy ration of two commercial banks would fall below the required level, stated the report based on stress test that is a risk management tool used to evaluate the potential impact on a firm of a specific event and movement components like earning, liquidity and capital.

The central bank had prescribed quarterly stress tests for commercial banks in the Monetary Policy of 2011-12.

“The overall credit shock scenario revealed that the credit quality of banks has not improved despite various measures,” the report stated, adding that banks are likely to face a difficult situation in case of a slowdown in recovery, downgrading of non-performing loans to loss category and increase in provisioning.

The liquid assets to deposit ratio of the total banking system and commercial banks has improved but more than half of the commercial banks may sink into a vulnerable situation, if withdrawals of deposits reach 15 per cent or higher. “The banks having a significant portion of institutional deposits may face a liquidity strain in case of withdrawals of deposits by their top institutional depositors,” it added.

Similarly, in mid-July 2013 five banks would have turned illiquid after deposit withdrawals between two per cent and five per cent of their total deposits for two consecutive days and of 10 per cent for three consecutive days. In mid-January 2013 some 19 banks were such vulnerable and in mid-July 2012 only five, the report stated.

Standard withdrawal shock means withdrawal of customer deposits of two  per cent and five per cent in the first two days and 10 per cent daily for three consecutive days. “The liquidity situation has improved since mid-January 2013, but not significantly compared to mid-July 2012,” it said, adding that in case of deposit withdrawals of five per cent, 10 per cent and 15 per cent, the number of banks whose liquid asset to deposit ratio would fall below the regulatory minimum of 20 per cent stands at one, four and 16 respectively.

As commercial banks still rely heavily on institutional depositors, large withdrawals by them will pose problems to them. “If the top three and five institutional depositors were to withdraw their deposits, the liquid assets to deposit ratio of 14 commercial banks and 21 commercial banks would dip below 20 per cent.”

According to the central bank report, the stress test results reveal that all the commercial banks – excluding two state-owned banks – have maintained a capital adequacy ration above the regulatory requirement when calibrated through their interest rate, exchange rate and equity price shocks. “In case of a market shock, 29 out of the 31 commercial banks – excluding two state-owned banks – would be able to maintain their capital adequacy ratio above the regulatory requirement of 10 per cent.”

A combined credit and market shock test based on a scenario of 25 per cent of the performing loans to the realty sector being directly downgraded to the substandard category of non performing loans and a fall in the equity prices by 50 per cent demonstrated that banks would not be affected, it added. “However, if 15 per cent of the performing loans deteriorated to substandard, 15 per cent of the substandard loans would deteriorate to doubtful loans, 25 per cent of the doubtful loans deteriorated to loss loans and the equity prices fell by 50 per cent, the capital adequacy ration of four banks would remain above the regulatory minimum, the capital adequacy ration of two banks would remain below zero per cent and the capital adequacy ration of 25 banks would lie between zero and 10 per cent.”

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