Commercial Banks, 2009–18

st A te - owned b A nks versus P riv A te b A nks in sout H A si A 67

FiGURE 2.7 india: Characteristics of the Average Client Firms of Scheduled Commercial Banks, 2009–18

Return on assets

Investment to assets

Debt to assets

Debt to equity

Total assets

0 0.50 1.00 1.50 2.00 2.50 3.00 3.50

PVTBs SOCBs

Sources: World Bank staff calculations using Prowess data. Note: All numbers are in percent except for total assets, which are in Rs, 100 billion. PVTBs = domestically owned private banks; SOCBs = state-owned commercial banks.

to the central government in part or entirely, depending on the budget constraints SOCBs face—that is, softer versus harder budget constraints. Gauging this loss involves estimating the probability of SOCB distress (PD) and financial loss given SOCB distress (loss given distress, LGD). The second type is the economic loss from SOCB distress due to forced adjustments by distressed SOCBs, such as in the form of changes in capital, debt, lending, or investments, which in turn can affect firms, consumers, and the government. Here, the focus is on the loss of private firms’ investment due to the frequent distress of SOCBs: that is, unrealized investments compared with the counterfactual of private firms being able to make investments through financing from banks not in distress regardless of whether those banks are private or state owned.

identifying Distress Using Financial Soundness indicators

We define a distress event as the breach of a threshold. In principle, the threshold could be determined by an economic relationship or a practical rule of thumb. The threshold value together with an actual value of an indicator variable then help identify a distress event.

A bank is considered to be in distress when it does not have enough revenues to cover its interest due: that is, when its ICR drops below 1. As robustness checks, we used three other indicators: ROA dropping below zero percent; the bank capital to risk-weighted assets ratio (CRAR) measured against a threshold related to the amount of capital above the minimum prudential requirement that banks want to keep;10 and the bank’s z-score, a popular solvency indicator in the literature (Laeven and Levine 2009; Ashraf and Shen 2019). The average annual probability of distress for a given group of banks— such as private banks or SOCBs—could be estimated as the average probability of distress using historical data on identified distress events (see equation (2A.1), in annex 2A, for details).

For the big picture of the analyzed data, figure 2.8 plots the ICRs for banks in India (panel a) using Prowess data—disaggregating new and old private banks—and in Bangladesh, Pakistan, and Sri Lanka (panels b, c, and d) using Fitch Connect data.11

One can observe that in India, the ICR of new private banks is comfortably above 1 most of the time for most of the individual banks—even though some outliers fall below 1. The situation is progressively worse