The effective non-performing assets of Indian banking industry, adjusted for internationally comparable norms, could be double from the reported figure of 4.5 per cent as of March 31, 2003, Fitch Ratings has said.

It also said that the shift in NPA classification to the 90-day norm from March 2004 could raise NPAs by 3 per cent.

In a special report titled 'The Indian Banking System', the agency has rated the outlook on the Indian banking system as 'cautiously optimistic'.

It has also warned that weakening development financial institutions, vulnerable non-banking finance companies and the inadequately supervised co-operative banks pose risks to the financial system.

Fitch added that the performance of the co-operative banks is unlikely to improve without a comprehensive overhaul of their regulatory framework, as well as improved corporate governance.

It pointed out that problems at Unit Trust of India have bought into focus the issues of inadequate supervision of this government sponsored mutual fund and the inadequacies of its internal control.

According to the rating agency, the asset quality of Indian banks have improved in the last few years. The net NPAs decreased to 5.5 per cent at the end of fiscal 2002 from 7.6 per cent in fiscal 1999.

However, it pointed out that exposures to problem accounts that have been restructured including loans to steel sector and to Dabhol continue to be classified as standard and are estimated to account for another 3 per cent of bank loans.

This could take the effective net NPA level of Indian banks to double the reported figure.

Fitch, however, added that that the buyback scheme, whereby gains from the sale of illiquid high coupon G-Secs would be tax exempt if used to write-off NPAs, could potentially reduce the NPA ratio of banks by up to 2 per cent.

It added the recent focus on trimming operating costs, improving technology and customer service standards, and increasing the share of non-interest income, has been important in improving the competitiveness of banks.