Vulnerabilities lurk in the banking sector

Spill-overs from the turmoil in the global banking system to India have been limited so far, but the big unknown is whether difficulties will flare up at home. Bank problems can arise via multiple channels. There may be banks that have not adequately hedged interest rate risk (as was the case with SVB), though this feels less of a worry in India than elsewhere given that the rise in interest rates since last year has not been especially steep. And more generally on the liabilities side of balance sheets, Indian banks look in good shape: the loan-to-deposit ratio is low and there is no heavy reliance on wholesale funding. But it is a different story on the assets side. A high ratio of non-performing loans and low regulatory capital are causes for concern. Loss absorption capacity – the loan loss rate needed to reduce the tier 1 capital ratio below the regulatory minimum of 4.5% – is lower in India than in other EMs. In a handful of banks, the loss absorption capacity is as low as 5%.