The Reserve Bank of India (RBI) on Monday raised concerns on rising bad loans of Indian banks, especially money given to infrastructure, retail and real estate companies, and said banks are likely to feel more pain from such loans in a high interest rate scenario unless they take “due care” of such risky assets.

“The concern is that recoveries have not kept pace with slippages since 2007-08. Rising interest rates and a substantial amount of restructuring done during the crisis period, if not done with due care, are likely to put further pressure on asset quality of banks,” RBI said in its annual report on banking trends and progress in 2010-11.

In the wake of the global financial crisis following the collapse of US investment bank Lehman Brothers Holdings Inc. in 2008, Indian banks restructured at least 5% of their loans across sectors. A sizeable chunk of such loans has already turned bad.

“...asset quality of banks needs to be closely watched in the changing interest rate environment as the sticky loan portfolio of small and medium enterprises might rise,” the apex bank said.

According to latest RBI data, loans to micro and small enterprises stood at Rs.4.7 trillion on 23 September, compared with Rs. 3.9 trillion a year earlier.

Noting that a “specific area of concern” is the “concentrated and high-pace lending” to the infrastructure sector by public sector banks, RBI said this raises “apprehensions of delinquencies in the future”. Also, the provisioning on account of high incremental growth in loans given to “sensitive sectors” such as retail and real estate may impact the profitability of banks.

Loans to the infrastructure sector, of which the majority is to cash-strapped power firms including loss-making state electricity boards, have been under stress in recent months. Bankers and analysts attribute this to lack of price reforms of power utilities and scarcity of fuel.

Bank loans to the infrastructure sector went up to Rs. 5.6 trillion at end-September, from Rs. 4.7 trillion a year earlier.

Of this, loans to power companies rose to as much as Rs. 3 trillion from Rs. 2.3 trillion. State-run banks have already stopped issuing fresh loans to loss-making state electricity boards and are currently in talks with some state utilities to restructure their loans.

Bank lending to the infrastructure sector is also constrained because many have reached their internal limits set for such loans. Besides, an increasing asset-liability mismatch is also affecting banks’ ability to fund long-term infrastructure projects. While loans have maturity of up to 15 years, the average maturity of bank deposits is one-three years.

Senior bankers said they are not too concerned about the asset quality in the system. “There is some stress due to the economic slowdown and high interest rates, but there is nothing alarming. Some of the banks may have seen a rise in the bad loans because of change into system driven calculation,” said R.K. Bansal, an executive director at IDBI bank Ltd.

“Overall, the incremental increase in bad loans is likely to be lesser in the next two quarters compared with the last two quarters,” Bansal said.

RBI’s report on financial stability in June had indicated that the Indian financial system remained stable “in the face of some fragilities being observed in the global macro-financial environment”.

A series of stress tests in respect of credit, liquidity and interest rate risks showed that banks remained reasonably resilient, though their profitability could be affected significantly.

Analysts, too, cautioned about the asset quality of banks in times of slowing economic growth and high interest rates. “We may see further deterioration in the asset quality of banks going ahead due to high interest rates and a slowdown in economic activities,” said Vaibhav Agarwal, vice-president, research, Angel Broking Ltd. He, however, added that the pace of rise is unlikely to be alarming.

According to the central bank, loans given to the farm sector contributed 44% of the total incremental NPAs of domestic banks in 2010-11, possibly due to higher growth registered in the credit flow to the segment in the last four years.

As at end-March, Indian banks have written off 10% of outstanding gross NPAs and this has helped the sector limit the growth in gross NPAs, RBI said