Indian banks are likely to gain more than they lose from the Reserve Bank of India’s (RBI's) move to tighten provisioning norms, said Standard & Poor's ratings services in a report today. The new levels will bring Indian coverage ratios in line with major Asian banks, said the report.

Last week the RBI in its Credit Policy said that it wants Indian banks to increase their provision cover to 70%. The current rules are that the moment the loan foes bad that is interest is not paid for 90 days then 10% is marked off as provisioning and in second year its 20%, in third year its 30% and in that year the entire amount is marked out. So provision cover under rules goes by this formula but banks sometimes very often or prudentially keep a 70% cover, they mark more than is necessary just as a buffer.

Now the RBI has asked for this and immediately you saw some of the banking companies go under pressure especially SBI and ICICI, the two big banks which have provision cover much less than 70%, closer to 40%.

The report from S&P’s says that higher provisioning cover is inherently good for banks and should be seen as a positive step.

S&P says the RBI has taken the step as it expects more loan defaults in coming quarters. Currently, loan losses are understated because of good growth, it says.

S&P acknowledges that the higher provisions will depress profits in the next four quarters.

At the industry level, this change in coverage requirement, along with expected increase in non-performing loan (NPL) is likely to take total provisioning to Rs 71,000 crore, of which Rs 21,000 crore will be because of the higher provision cover.

In an interview with CNBC-TV18, the author of the report, Ritesh Maheshwari, Senior Director Financial Institution Ratings for Asia at Standard and Poor's, spoke on the issue.

Here is a verbatim transcript:

Q: Take us through the argument—You seem to be saying that the idea is good because you are expecting bad assets to increase in the Indian banking system and therefore this is a good preparatory step?

A: Yes we have been believing for some time that Indian banks had gone through a Bennie phase and now we are entering a phase of consolidation where the asset growth which happened over the last few years is bound to cause new non performing assets (NPAs). That, with the tightening of business environment means even more so increase in the NPLs. So we have been feeling that the credit cost for Indian banks would be rising and we have been incorporating that in our analysis as well which was not in sync with the provisioning which Indian banks had been making but our ratings were reflecting the true state.

Q: Why or how much you expect the NPLs to increase, we are seeing some improvement in the sales revenues of companies, we have seen their ability to raise equity- in your analysis what will contribute to the increase in NPLs—one had thought that we slowdown phase kind of ending if anything the NPLs might actually decrease?

A: NPLs will increase for one simple matter—we have seen exceptionally low levels of NPLs in India which has been a combination of very good economic environment, a very strong profitability which has prompted banks to make heavy write offs and surfaces results which has given very good recoveries. So we have come to a NPA number which was unsustainable at the Indian operating environment level. So we are now bound to go back to what is the more normal level which we would believe is 3-3.5% and we expect by the year 2011 fiscal we should be touching 3%.

Q: Indian banks right from the central bank have been commended for their safety and their high capital adequacy ratios (CARs). The fact that now they are going to be provisioning a lot more consequently rating agencies like yours have been positive on this move—do you sense that it  may actually result in some bit of rating upgrade rather than a downgrade because of the way you are viewing it and the safety it will bring forward?

A: From an analysis point of view we have always been expecting cuts to be higher so which means this move is an acknowledgment of that. This will ensure that balance sheets start to account it for that in as many terms and to that extent. So really speaking, if I had been doing my analysis right and giving Indian banks to probably a minus on that, I don’t see this number changing per se leading either to downgrade or an upgrade.

Q: There is this argument about technical write-offs getting included in the provision cover and if that happens many of the banks are already in the 70% provision cover. First explain to us what is this technical write off because one thought those are for assets which are not in the NPA basket anyway and here the RBI is not looking very kindly at this explanation—can you take us through where you stand?

A; Technical write offs are basically the write offs which are done at the head quarter level but the recovery level at the branch level continues. So the borrower doesn’t come to know that his loan has been kind of written off in the banks books. So that is something which you can call a prudent step taken by banks in imagining that this money is very unlikely to come, so from that point of view balance sheet is healthier.

Q: If it is written off then it stands to reason that the banks demand that we should not provide for it is legitimate?

A: Banks are not providing for it. What the banks are asking for is that take the write off as 100% provision. So let me write that back as the written off NPA amount into the NPA and the 100% provision amount into the provision which as you would imagine if I add back something which is 100% provision cover it will improve the provisioning cover at the whole portfolio. That is essentially the pillar of the argument that the Indian banks here are presenting to the regulator.

Q: Where do you stand on that argument?

A: This is more of an accounting issue, more of regulatory norms issue. Being a global rating agency we have always been doing our own estimation on top of that because while in India you have seen 50% cover, in Singapore we see 100% cover and in Thailand we see 40% cover. We do our own estimate and from that point of view our ratings reflect that. So to the extent the numbers will change, it will mean that numbers will be more transparent and more believable to us but I do not think it will make any change in any credit profile. So we won’t make any rating changes. So to that extent this per se does not change the health of the banks but it improves their picture.