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Levelling the Playing Field for Banks

By Viral Acharya

Viral Acharya on flight from US treasuries

Public sector banks need to be slowly weaned off their funding advantage coming from government guarantees.

Over the past year, the non-performing assets (NPAs) of Indian banks have risen steadily. They now exceed 5% of advances. This is a rather high number in an absolute sense, but also in the relative sense compared with banks in other countries. The NPAs are significantly higher for public sector banks than private lenders. The real problems may be deeper as many loans are under restructuring and not yet recognized as NPAs for their full likely losses.

While these balance-sheet numbers suggest concern regarding future losses, market-based data can help assess the preparedness of Indian banks to deal with these losses. At the V-Lab in New York University’s Stern Business School, we estimate the capital needs of banks in future stress. We use market data to assess the downside risk of banks and assess their gearing in a stress scenario by comparing their book liabilities to market value of equity after taking account of the downside risk.

Our estimates suggest that in the event of a minus 40% correction to the global market over a six-month period, as seen in the Great Depression and the Great Recession, publicly traded Indian banks and financial firms will require over $80 billion of equity capital to maintain a market equity ratio of 8% relative to their assets.

Read full article as published on LiveMint.com

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Viral Acharya is the C.V. Starr Professor of Economics and the Director, NSE-NYU Stern Initiative on the Study of Indian Capital Markets.