Banks' over exposure to few large cos can erode equity: Kotak

Eminent banker Uday Kotak has said that Indian banks face some 'real' risks from their disproportionate exposure to a few large companies, particularly in sensitive sectors like infrastructure.

Without naming the banks or their corporate customers accounting for large slice of loans, Kotak said that "a few large companies particularly in sensitive sectors like infrastructure, have a disproportionate slice of banks' balance sheets.

Therefore, concentration risk is real for Indian banks, Kotak said in his annual message to the shareholders of Kotak Mahindra Bank. "Further, a well intended measure of smoothening cash flows through restructuring runs the risk of becoming a tool for 'ever greening'," he said.

The term 'ever greening' is used for a loan-restructuring exercise under which banks provide additional but indirect loans. Reuters

The term 'ever greening' is used for a loan-restructuring exercise under which banks provide additional but indirect loans to troubled borrowers to help them meet their existing obligations. While this helps the banks avoid the loans turning bad for some time, it increases their exposure to the distressed borrowers.

Kotak said that one the most important challenges in the Indian banking sector is its ability to define and price risk."The sector very often takes equity type risks for debt level returns," said the Executive Vice Chairman and Managing Director of Kotak Mahindra Bank.

About the "much debated governance deficit challenges", he said it is critical to get right balance between politics and economics, but with "a little wind from the policy front, India has the ability to bounce back in due course of time."

Kotak, however, said that the situation was even worse in the global financial sector, which has been brought "down to its knees" because of some self-proclaimed masters of global finance forgetting the basic principle of prudent lending.

"I am reminded of my early days, when I was taught the first principles of finance: if you put in Rs 10 of equity and borrow Rs 100, you can lend out Rs 110. However, if just Rs 5 of loans out of the Rs 110 go bad, you lose 50 percent of your equity, and it takes just Rs 10 of assets going bad to bankrupt you!," he said.

"It is quite surprising how global finance had missed this basic principle, their vision blurred perhaps by the jargon of risk weights, tier II capital, et al. "We have seen financial institutions with less than 2 to 3 percent equity, i.e. effective debt equity ratio of 40 and 50 times, positioning themselves as masters of global finance.

"And that is what has brought the financial sector down on its knees. It is important that banks focus both on "return on equity" as well as on "return of equity"," Kotak said. Kotak said banks have started focussing more on their profit and loss statement, rather than balance sheet, over the years.

"In fact, particularly for banks, the Balance Sheet is more important, and P&L is only a derivative of the Balance Sheet," Kotak noted."As I write this note, the world is on the edge about the future of Euro zone. 'Grexit' is the new terminology.

A global bank has announced a $2 billion treasury loss on trading credit derivatives. Facebook is having trouble with its post IPO phase. The business of money is truly 'fragile, handle with care'," Kotak said.

On the challenges before the Indian economy, Kotak said that there were some valid concerns about the global economy and policy.

"But India's macro challenges are more than just global headwinds," he said, while listing out critical issues such as high oil and high gold imports, as also the inability to pass on higher oil costs.


Updated Date: Dec 20, 2014 09:55 AM

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