The global financial crises have India in their grip, too. Weak demand and a sharp fall in commodity prices have adversely impacted the profitability of Indian companies. In such a situation, the smaller players are predictably more affected compared with larger ones, particularly the highly leveraged companies facing an acute shortage of funds.

This would lead to solvency crises, which occur when the value of assets carried on the balance sheet of a company reduces, impacting the company's ability to pay back loans. Banks will then need to write down the value of the loans, as they would not receive the total amount of loan borrowed by the corporate. This, in turn, means the banks' bad loans would rise. Job losses and uncertainty in current jobs could mean retail bad loans will rise, too.

While the rise in bad loans is inevitable, analysts feel the impact of the slowdown on the banking industry would be lesser than that seen in the previous cycle.

This is due to lower leverage of corporates (0.36 times versus 0.88 times in FY97), banks' limited exposure to vulnerable sectors, as also better restructuring and recovery practices, analysts Pathik Gandotra and Neha Agarwal of IDFC SSKI wrote in a report dated February 24.

"Our view rests on analysis of components of bank credit, detailed evaluation of balance sheets of around 3,000 companies and assessment of personal income levels. After applying our credit screens, we see 14% of bank credit under stress, of which a proportion is likely to manifest as NPAs or get restructured," the analysts wrote.

The impact of bad loans is expected to spread over the next 2-3 years and gross bad loans are expected to peak in FY2011 at 5.7%.

Experts feel State Bank of India and Bank of India are relatively more vulnerable than the others in dealing with rising bad loans. As on December 31, SBI had the highest net bad loans to the tune of Rs 6,864 crore and the percentage of net bad loans stood at 1.36%. Bank of India's bad loans stood at Rs 699 crore and percentage of net bad loans at 0.52%.

Pallavi Pengonda/ DNA-Daily News & Analysis Source: 3D Syndication