Banking Sector: Higher provisions on UFCE may not affect much

Emkay Global Financial Services has come out with its report on banking & financial services:

• Draft guidelines suggest higher provisions/risk weights for exposure to corporates with unhedged foreign currency exposures (UFCE) to protect banks from volatility in currency. 
• Since provisions/risk weights apply to total banking exposure (including hedged FCE or domestic loans), it will impact bank even if they have INR exposure to corporate. 
• Easiest way out for banks would be to collectively force borrowers to buy hedges against UFCE and thereby reduce impact. This will also be positive for fee income.
• Impact could be more for banks with higher non-agri/non-retail exposures. We guesstimate impact of 3-6bps on ROA for PSU banks and even less for some of the private banks.
• The higher provisioning requirement is not limited only to the UFCE but on total banking exposure. Thus, even if Bank A does not have any UFCE to a corporate, it will have to do additional provisions on its own exposure (INR or UFCE doesn’t matter) even if the UFCE belongs to some other bank. 
• The idea behind higher provisions/risk weights is to safeguard all exposures of banking sector to a corporate which is exposed to currency volatility due to UFCE. 
• Corporates can claim natural hedge (FX revenues) which will have to certified by the statutory auditors. 
• The maximum impact of the measure on banks can be limited to 6-7 bps. This will be related only to corporate loans (manufacturing + services), which are 60 percent of the total loans. Assuming 50 percent of these have taken FX loans and 50 percent of them may have kept them unhedged, this would leave us with 15 percent of the total loans or 9 percent of total assets. Even applying 40bps additional provisions, this would have 6bps impact on RoA. 
• Thus, the impact will be uniform for banks, notwithstanding whether one has given INR or FX loans to the corporate and overall impact can be mitigated. Impact may be marginally higher for banks which have participated in both, INR and FX loans of a particular bank. However, the impact will be lower for the banks with higher retail or agriculture exposure.
• We believe that the banks collectively may in fact force some of these corporates to buy hedge cover and get fee income from them.

Impact could be limited:
It is difficult to assess exact impact of the same on the profitability, since the same will depend on the likely loss to EBID ratio for individual borrowers. However, to guesstimate the same, we have assumed that 50 percent of the borrowers for banks have FX loans and of which 50 percent have kept exposure unhedged.

Courtesy: www.moneycontrol.com