Degrading quality of assets of banks might pose a challenge on their profitability in the upcoming quarters. This comment has come from the rating agency CARE based on the fact that some borrowers are still defaulting on loans even after restructuring the lending mechanism by banks.

It also says that the losses arising due to these bad loans can be neutralized by the rise in interest margins as the shrinkage in high cost deposits takes place.

RBI, in 2008 had allowed banks to give some more time for repayment to troubled borrowers and not declare them as defaulters. The central bank had said that banks should restructure the repayment mechanism and relax the debt burden on these borrowers by reducing their EMI amount and increasing their repayment period.

CARE's analysis said that the total amount of restructured assets as on December 31, 2009, stood at around Rs 130,000 crore, amounting to around 4% of total advances. It has warned saying, "Given the huge quantum of restructured assets on their books, additional slippage could impact profitability of PSU banks."

In terms of bad loans estimation, CARE's analysis says, "The overall gross NPA ratio for PSU banks was influenced by increase in slippage (when a loan slips to sub-standard category) in Bank of India, Bank of Baroda and SBI." It has estimated the gross NPA level to be at Rs 80,000 crore as on December 2009, an increase by 30% over December 2008 levels.

An increase in NPA would hamper banks' profitability. "A higher NPA provision coverage may no doubt mean reduced profitability for those banks who are presently having a coverage far below the stipulated minimum, but it would at the same time, fortify banks against possible credit losses and thereby strengthen their balance sheet," said the report.

CARE expects that a rise in credit off take will improve the net interest margins (NIM) of banks. The NIM of banks has improved on quarter to quarter basis over September 2008 quarter.