The Reserve Bank of India (RBI)’s deputy governor NS Vishwanathan stated that public sector banks in India may not have priced risks correctly while lending loans. Vishwanathan stated this while speaking in an event organized by CARE Ratings in Mumbai. According to him, the recent onslaught of non-performing assets (NPAs) in public sector banks could be the result of banks not assessing the risk factor correctly.
The inability of banks to correctly arrive at risk pricing represents a fundamental problem, and banks must develop their capabilities in risk-based pricing. He stated that creditors must arrive at the interest rate for a large loans by assessing the risk factor. This type of pricing requires fair assessment and proper understanding of risks. This capability is required for banks rather than merely relying on collateral and guarantees provided by borrowers.
He stated, “Banks should charge interest rates which commensurate with risk involved in the project. However, in many instances risk is underpriced. It can be safe to assume that proper risk had been done by banks, many of the current NPAs could have properly assessed well in advance.”
During the event, Vishwanathan also stressed the importance of writing strong covenants and strictly enforcing them. All these statements mainly focused on the importance of detecting stress signals early and taking decisions through joint lenders forum.
The RBI deputy governor’s statements have come at a time when public sector banks in the country are suffering a huge crisis with regard to NPAs. According to the finance ministry, NPAs have crossed Rs.8.5 lakh crore in the first half of the current fiscal year. Banks are also facing issues related to bankruptcy proceedings and debt resolution.
Banks could lower their overall risk by charging risk-adjusted interest rates. Defaults by corporates is the major reason for surging bad loans across the country. With risk-adjusted interest rates, banks could position themselves well and minimize their NPAs.