Information about Asia and the Pacific Asia y el Pacífico
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India: Selected Issues

International Monetary Fund
Published Date:
February 2006
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Information about Asia and the Pacific Asia y el Pacífico
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V. India—Credit Growth and Related Risks1

1. In 2004—2005, annual growth of bank credit in India exceeded 30 percent (Figure V.1). In contrast, total deposits of the banking system grew only by 15.4 percent over the same period. As a result, the credit-to-deposit ratio exceeded 60 percent in March 2005, and nearly reached 100 percent when only new loans and deposits are considered. For foreign banks, the difference between the growth rates of loans and deposits was particularly large (24.5 percent and 7.9 percent, respectively), bringing their credit-to-deposit ratio to 87 percent by the end of the period.

Figure V.1.India: Growth in Total Credit and Deposits, 2000–05

Source: Reserve Bank of India.

2. In 2004, India had the fastest real rate of credit growth in Asia, followed by Indonesia (Table V.1). However, India was outpaced by several countries in emerging Europe and Central Asia, where real rates of credit growth exceeded 40 percent, driven in part by financial deepening and by the entry of foreign banks. Credit growth rates were lower among the industrialized countries in Europe, but in some of them significantly exceeded the GDP growth rates (notably in Ireland, Spain and Greece).

Table V.1.Real Credit Growth in Selected Countries and Regions, 2002–04(In percent)
Real Growth in CreditPrivate SectorCapital to Risk-NPLs to
to Private Sector 1/Ccredit to GDPWeighted AssetsGross LoansROA
Sri Lanka4.49.712.928.629.931.510.016.0
China18.219.47.1135.8147.1140.53.9 2/15.6 3/
Emerging Asia6.
Memorandum items:
Emerging Europe15.122.521.032.134.738.
Western Europe3.05.07.1133.7137.2141.
Latin America1.6-3.93.833.831.531.
Middle East and
Central Asia14.615.820.535.136.037.618.313.61.7
Sub-Saharan Africa11.511.88.314.115.214.716.913.33.1
Source: IMF, Monetary and Financial Systems Department, Financal System Trends, September 2005.

Deflated by end of period CPI.

Not risk-weighted capital ratio.

State-owned commercial banks.

Source: IMF, Monetary and Financial Systems Department, Financal System Trends, September 2005.

Deflated by end of period CPI.

Not risk-weighted capital ratio.

State-owned commercial banks.

A. Reasons of Fast Credit Growth in India

3. Existing literature generally identifies three main drivers of rapid credit growth (IMF, 2004; Hilbers et al, 2005). First, credit tends to grow more quickly than output during the development phase of an economy (“financial deepening”). Second, credit typically expands more rapidly than output at the beginning of a cyclical upturn due to firm' investment and working capital needs. Third, excessive credit expansion may result from inappropriate responses by financial market participants to changes in risks over time. For example, over optimism about future earnings may boost asset valuations, lead to a surge in capital inflows, increase collateral values, and allow firms and households to sharply increase borrowing and spending.

4. In practice, it may be hard to distinguish between these three reasons of fast credit growth, since all three may be present in various degrees at the same time. Financial deepening can easily coincide with the cyclical growth in lending, which, in turn, can be accompanied by an asset price bubble.

5. In India, credit expansion is taking place against the backdrop of relatively shallow financial markets, suggesting that financial deepening may be an important factor behind this rapid growth. To the extent that it reflects financial deepening, fast credit growth should be seen as a positive development, since a number of recent studies indicate that financial development is one of the determinants of economic growth.2 In India, the ratio of private sector credit to GDP grew from 33 percent in 2002 to around 40 percent in 2005. This is still relatively low, although it is higher than in most developing countries that experienced high rates of credit growth in 2002–04.3

6. Many types of credit—in particular retail credit—are growing from a very low base, as banks in India have tended to invest a large share of their deposits in government securities. Even after a recent decrease, government securities still account for 31 percent of banking system assets, while net loans account for about 50 percent. Although growing rapidly, retail loans (which include housing loans, consumer durables, credit card receivables, and other personal loans) are still small at about 7 percent of GDP. The expansion of the retail banking segment can be attributed to a growing middle class with high disposable income, wider choices of consumer durables, increased acceptance of credit cards and increased demand for housing loans, spurred by attractive tax breaks. In addition, the RBI has taken a number of initiatives to increase transparency and competition in the credit market, including the dissemination of information on lending rates of banks since 2002, and the creation of a credit registry.

7. Cyclical factors are also present, with strong income growth, rapidly growing consumer demand, and decreasing borrowing costs contributing to rising demand for credit. Cyclical credit growth is more of a potential cause for concern, since in periods of booms, risks tend to be underestimated, which can lead to an increase in nonperforming loans ratios after the boom has ended. India is now going through an upward phase of an economic cycle, with real GDP growing at an average annual rate of about 7 percent over the last three years. Staff estimates using the Hodrick-Prescott filter indicate that recently credit growth has begun to outpace the cyclical upturn (Figure V.2). In 2004, credit growth in India was 8 percent above trend, compared to 1 percent for the GDP.

Figure V.2.India: Cyclical Components of Real Credit Growth, 1994–2004 1/

Sources: Reserve Bank of India; and staff estimates.

1/ Trends are estimated using the Hodrick-Prescott filter.

8. Current rapid credit growth is also accompanied by considerable exuberance in asset markets, suggesting that asset overvaluation may be a concern. Real estate prices in major metropolitan areas (such as Mumbai, Bangalore, and Kolkata) have increased at an annual rate of about 20 percent since 2003, with prices accelerating in the second half of 2004. In addition, Indian stock market has been growing at an annual rate of about 37 percent since early 2004.

B. What Types of Credit are Growing?

9. Credit growth has been broad-based (Table V.2). In the year ending in March 2005, nationalized banks4 (accounting for 47 percent of total credit of the banking system) saw their credit growing fastest, at 33.6 percent, but other groups of banks were not far behind. Credit in metropolitan areas was the fastest growing (Bangalore and Mumbai witnessed the fastest growth of credit, 49 percent and 42 percent respectively), but credit in rural areas (representing 9 percent of the total) also grew by 25 percent.

Table V.2.India: Growth of Loans and Deposits by Type of Bank and by Region
Share in
DepositsDepositsLoansLoansTotal Credit
(Annual growth rates, in percent)(In percent)
By groups of banks
SBI group19.715.716.126.023.1
Nationalized banks16.215.915.633.647.4
Foreign banks28.65.215.32466.7
Regional rural banks12.110.018.22472.8
Other scheduled commercial banks23.417.823.831.920.1
All scheduled commercial banks18.715.617.330.6100.0
By population groups
By major banking centers
Source: Reserve Bank of India
Source: Reserve Bank of India

10. Over the last 10 years, the share of industry in the total loan portfolio of commercial banks has declined. This share fell from 54 percent in 1995/96 to 38 percent in 2004/05. Over the same period, Indian corporations have reduced their reliance on bank loans as a source of financing, and started to use the capital market and external borrowings more actively. The share of industries in the total loan portfolio was taken up by consumer loans and loans to priority sectors (which include agriculture and small scale industries).

11. This trend continued in 2004/05, with priority sectors the main contributors to the growth in nonfood credit (Table V.3 and Figure V.3). Priority sectors accounted for 40 percent of the total 28 percent growth of nonfood credit. Banks exceeded the government's 23 percent target loan growth in priority sectors by a margin of 8 percent. Within the priority sectors, agriculture loans in particular were an important driver of growth with a 35 percent increase in 2004–05. Industrial loans and housing loans have been also important drivers of the recent credit growth.

Table V.3.India: Credit Growth by Sector
(Percent change)
Priority sector24.731.0
Small-scale industry9.015.6
Industry (medium and large)5.117.4
Nonbanking financial companies18.910.8
Wholesale trade10.136.0
Export credit17.214.3
Gross nonfood bank credit17.527.9
Source: Reserve Bank of India.
Source: Reserve Bank of India.

Figure V.3.India: Sectoral Contribution to Credit Growth, March

Sources: Reserve Bank of India.

12. Consumer credit in India is starting from a very low base, but is growing rapidly. In 2004, total household credit (which includes mortgage loans and consumer durables credit) was lower than in most emerging Asian markets, when measured in percent of GDP or of total credit (Table V.4).5 However, mortgage loans were growing at a faster rate than in any other emerging Asian economy, and credit card debt was picking up as well, albeit from very low levels.

Table V.4.Consumer Credit in Asia, 2004
Hong KongIndia 1/Korea 2/MalaysiaPhilippines 2/SingaporeTaiwanThailand
Household credit (percent of GDP)
Household credit (percent of total credit)35.622.056.244.516.450.341.624.4
Mortgage loans (percent of total household credit)83.047.355.156.538.461.959.865.9
Credit card debt (percent of total household credit)6.43.335.437.716.135.431.726.8
Growth of mortgage loans in 2003–04-1.942.015.515.44.115.915.515.6
Growth of credit card debt in 2003–040.736.0-
NPL ratio for credit cards debt5.46.334.
Sources: For India, Reserve Bank of India; for other countries, “The Growth of Consumer Credit in Asia,” HKMA Quarterly Bulletin, March 2005.

Numbers for end-March 2004.

For Korea and the Philippines, NPL ratio is for 2003.

Sources: For India, Reserve Bank of India; for other countries, “The Growth of Consumer Credit in Asia,” HKMA Quarterly Bulletin, March 2005.

Numbers for end-March 2004.

For Korea and the Philippines, NPL ratio is for 2003.

C. Risks from Rapid Credit Growth

13. While most lending booms do not end up with a banking crisis, most significant episodes of banking distress in the last 20 years were preceded by rapid credit growth (Figure V.4). Various empirical studies estimate the likelihood of a banking crisis following a lending boom to be as high as 20 percent.6 Some countries that experienced a financial crisis in the last 20 years had a credit-to-GDP ratio at the time of the crisis as low as 40 percent, similar to the current Indian level.

Figure V.4.Average Credit to GDP Ratio in Eight Countries

That Had Financial Crisis in 1987–1997

Source: Duenwald, Gueorguiev, and Schaechter (2005).

14. Fast credit growth can trigger banking distress through two channels—macroeconomic imbalances and deterioration of loan quality. At present, macroeconomic risks from fast credit growth appear to be minimal in India. Although credit growth has led to a reduction of bank' holdings of government securities, this has so far led to only a modest increase in T-bill rates. Moreover, while imports and the trade and current account deficits are rising, RBI reserves are sufficiently large. The key risk, then, appears to be credit risk, to which we now turn.

Credit Risk

15. In cases when rapid credit growth did lead to a banking crisis, it was usually due to a failure by banks and supervisors to maintain asset quality, properly account for risks, and to ensure that adequate buffers were built in anticipation of a possible downturn. In times of rapid credit growth, the mere quantity of loan applications makes risk assessment difficult, and often results in a decreased quality of new loans. In addition, risk tends to be underestimated during booms and overestimated in recessions.

16. The aggregate NPA ratio of the Indian banking system is currently low, but may increase in the future. The aggregate NPL ratio was 5 percent at end-March 2005, after having steadily decreased for the last five years. However, the most recent decreases in the NPL ratio may be due in part to credit growth, as a growing share of the stock of loans is relatively new. Deterioration in asset quality typically occurs with a lag of 1–2 years, since a loan is classified as nonperforming only after it has not been serviced for a certain time. Therefore, the NPL ratio may increase in the future, and needs to be closely monitored.

17. The NPA ratio is highest in public banks, which dominate the sector, and in lending to priority sectors, which is the biggest contributor to the overall credit growth (Table V.5). The ratio of net NPAs to capital for public banks was at 13.6 percent in March 2005, significantly higher than for private or foreign banks. Loans to priority sectors had a 6.7 percent gross NPA ratio, while loans to small scale industries had an aggregate NPA ratio of 11.2 percent. These numbers may not be high enough for serious concern at the moment, but they suggest that the policy of encouraging banks to increase their lending to priority sectors should at the least be conditional on appropriate credit assessment by banks.

Table V.5.India: Nonperforming Assets, March 2005
Public BanksPrivate BanksForeign BanksAll Banks
NPAs to gross loans5.
Provisioning ratio61.350.062.859.7
Net NPAs to capital13.69.54.511.7
NPA ratios in:
Priority sectors7.
Small scale industry11.611.12.711.3
Consumer loans2.
Mortgage loans2.
Credit card debt25.
Source: Reserve Bank of India.
Source: Reserve Bank of India.

18. State banks have played the major role in rapid growth in domestic credit. This creates another potential source of risk, because state banks can have a different objective function than private banks. As a result, they may provide credit based on considerations such as economic development needs, without sufficient assessment of risks. In addition, empirical studies suggest that the presence of foreign banks may lower risks through improved risk management techniques and more realistic provisioning against bad loans, and may contribute to making more capital or liquidity available when needed (Moreno and Villar, 2005; Levine, 1996). Key financial soundness indicators of foreign banks in India are somewhat better than for public or domestic private banks (Table V.6).

Table V.6.India: Key Financial Soundness Indicators by Bank Ownership, end-March 2005
All BanksState BanksPrivate BanksForeign Banks
(In percent)
Market share (in assets)100.074.418.86.8
Capital to risk weighted assets12.812.912.214.0
Tier I capital to risk weighted assets8.48.08.511.2
Gross NPLs to gross loans5.
Net NPLs to capital11.713.69.54.5
Personnel expenses to total income15.317.29.010.3
Return on assets0.
Return on equity13.614.711.710.8
Source: Reserve Bank of India.
Source: Reserve Bank of India.

19. Rapid credit growth also puts pressure on bank' capital. New loans to the private sector increase risk weighted assets, making it more difficult for banks to satisfy the capital adequacy requirement. So far, capital adequacy of the system appears sound. The aggregate capital adequacy ratio was at 12.8 percent as of end-March 2005, and only two banks out of 87 were violating the RBI requirement of 9 percent. However, there are indications that some banks may have started to feel pressure on their capital. At end-March 2005, eight banks had a CAR between 9–10 percent (against only one bank a year before), and there were reports of some banks issuing significant amounts of subordinated debt to shore up their Tier II capital.

Stress Tests

20. Staff conducted a series of stress tests, to assess the vulnerability of the Indian banking system to credit risk. Three scenarios were considered: (i) an increase in provisioning to the levels consistent with international best practices;7 (ii) an increase in NPLs by 25 percent; and (iii) an increase in NPLs due to a portion of the “new” loans becoming nonperforming. In the third scenario, we assume that all loans made in the last two years are currently performing. Then, we assess the effect of these “new” loans becoming nonperforming at the same NPL rate that the “old” loans currently have. Assuming that the NPL ratio of the “old” loans reflects the average quality of risk assessment mechanisms currently in place and the average riskiness of lending in India, this is a fairly realistic scenario.

21. The results of the stress tests indicate that the Indian banking system as a whole is resilient to the tightening of provisioning requirements and to the deterioration in credit quality that typically accompanies periods of rapid credit growth (Table V.7). No group of banks would experience serious capitalization problems as a result of increased provisioning or a 25 percent increase in NPAs (in the latter case, only the old private banks would have the CAR fall under 9 percent). In the third scenario, which has the biggest effect on bank' capitalization, most groups of banks still remain above or very close to the capital adequacy requirement of 9 percent. The only exception are old private banks, whose aggregate CAR falls to 6 percent, but these banks together account for less than 6 percent of the market. Capital adequacy of all of the six largest banks in the country remains above 8 percent in this scenario. However, the next four banks (accounting for 12 percent of the system's assets) would see their capital adequacy fall to the levels of 4 to 7 percent. While this is a significant reduction compared to their current levels of capitalization, it need not present a systemic risk for the banking sector, and the affected banks should be able to restore their capital adequacy relatively quickly through new capital injections, consolidation, or other means.

Table V.7.India: Stress Tests—Capital Adequacy Ratio Under Various Scenarios
All BanksPublic BanksPrivate BanksPrivate BanksBanksLargest Banks
Actual at end-March 200512.812.812.512.114.112.7
Stress tests scenarios
Increased Provisioning12.011.910.711.713.811.8
NPLs increase by 25 percent10.410.07.511.113.210.1
New loans become NPLs
at the same rate as old loans9.
Memorandum item:
Market share (assets)
Sources: Reserve Bank of India; and staff estimates.
Sources: Reserve Bank of India; and staff estimates.

Other Potential Risks

22. In addition to borrowing domestically from banks, large Indian companies have also increased their external commercial borrowing, and raised substantial funds on the capital market. According to some reports, in the first eight months of 2005, Indian corporates raised almost three times more funds from the securities markets than from the banking system. When companies borrowing externally do not have foreign exchange earnings, this may create an indirect credit risk for local banks, since those companies can experience financial difficulties in case of a depreciation of the rupee. However, while it was not possible to quantify this risk, most market participants believed that it was negligible, since companies borrowing in foreign exchange are primarily exporters.

23. Some banks that are experiencing high rates of credit growth have very high loans-to-deposits ratios, and may encounter liquidity problems. While the aggregate loans-to-deposits ratio is slightly over 60 percent, it is not evenly distributed (Table V.8). In bank branches that had loan-to-deposit ratios over 100 percent in March 2005, loans grew by 30 percent in 2004/05, compared to a 5 percent growth in deposits. While so far there is no evidence that banks are experiencing serious liquidity problems, such problems may arise in the future, if current trends continue.

Table V.8.India: Distribution of Reporting Bank Branches by Loans to Deposits Ratio, end-March 2005
Loans to DepositsDeposits GrowthCredit Growth
(%)Rate (%)Rate (%)
Source: Reserve Bank of India.
Source: Reserve Bank of India.

24. Experience of other Asian countries suggests that the growth of consumer credit has to be closely monitored (Box V.1). As mentioned before, consumer credit is still at low levels in India, and the NPL ratios are low (2.2 percent for all retail loans, 1.9 percent for housing loans, and 7.9 percent for credit card debt). However, the rapid rise in credit card debt (36 percent in 2004/05), as well as the already sizable share of nonperforming loans and reports of unfair market practices, point to the possibility of future problems. Experience of other countries shows that developments in this area need to be closely monitored, especially given the current exuberance in real estate and housing markets, and in the environment where the concept of consumer credit is new for most borrowers. The RBI is well aware of these risks, and has recently issued a set of guidelines for credit card operations, aimed at raising consumer awareness and punishing the unfair market practices.

Box V.1.Korean Credit Card Crisis: Lessons for India

In recent years, Korea experienced a period of rapid growth in consumer credit, in particular credit card debt. Household debt increased from 37 percent of GDP in 1999 to more than 62 percent in 2002. During this period, many credit card companies abandoned good credit risk practices and competed aggressively to increase market share. The government itself sought to promote the use of credit cards as a stimulus to consumption through tax incentives, lottery promotions, and the relaxation of restrictions on cash advances. Supervisory oversight of the conditions under which lending institutions extended credit on cards was not strong enough, a factor cited by the Bureau of Audit and Investigation in its subsequent examination of the crisis. Both lenders and the government were implicitly relying on what they perceived to be the traditional financial conservatism of Korean households and did not closely monitor changing attitudes or incentives to encourage borrowing.

The problem was exacerbated by the structure of the loans extended on the cards issued. As much as 50 percent of credit card usage in Korea financed a cash advance payable in full at the end of one month, not a revolving credit balance subject to a minimum monthly payment. Combined with the lack of full information on borrower payment histories and lax screening, it generated an incentive for many borrowers to rotate payments on cards until limits were eventually hit. Eventually, this resulted in a large number of individuals delinquent on multiple credit cards.

The overuse of credit cards eventually resulted in an explosion of household defaults, with nearly 10 percent of the adult population becoming delinquent on their debts. The impact of the loan losses on financial institutions has been limited by strong bank earnings on their other lines of businesses, recapitalizations of impacted institutions, and government intervention. However, the effect of the overhang on debtor households and consumption has been more pronounced and long-lasting.

D. Possible Steps by the RBI to Mitigate the Risks

25. Although there are currently no signs of serious asset quality problems in the banking system, rapid credit growth combined with risk factors noted above creates the potential for future problems. The aggregate ratio of credit to deposits is still moderate, capital adequacy ratios are sufficiently high, and the NPA ratios are low. Nevertheless, credit developments need to be closely monitored, to ensure that potential risks do not materialize. Prudential rules and regulations play a crucial role here.

26. The RBI has already taken several steps to respond to potential risks. The RBI has increased the risk weights on consumer and housing loans, and on commercial real estate and capital market exposures.8 It has also tightened loan classification rules in line with the international best practices, by requiring that a loan be classified as nonperforming after it has not been serviced for 90 days, instead of the previous 180 days. More recently, general provisioning for nonpriority sector loans was increased from 0.25 to 0.4 percent.

27. Nevertheless, additional steps could be considered, especially if the rapid credit growth continues. Experience of other countries that had periods of high credit growth can be useful. Hilbers et al, 2005 explored the policy options that are available to counter and reduce the risks resulting from fast credit growth. Table V.9 outlines those regulatory measures that could be considered by the Indian authorities. The general approach is to ensure that the necessary safeguards against excessively risky lending are in place, while at the same time allowing the financial deepening to continue. These recommendations are in line with the Basel Core Principles (BCP), and their implementation would improve India's compliance with these standards.

Table V.9.India: Existing Bank Regulations and Possible Changes
Area of SupervisionCurrent Indian RegulationPossible Further Steps
Capital AdequacyBanks are required to maintain CAR of at least 9 percent. Risk weights were recently raised for housing loans (from 50 percent to 75 percent), consumer loans, capital market and commercial real estate exposures (from 100 percent to 125 percent).Increasing risk weights for loans with high NPL rates (e.g., priority sector lending).
Asset Classification and Loan Loss ProvisioningLoans classified as sub-standard when overdue for at least 90 days; doubtful, if they stay in the sub-standard category for 12 months; and loss, when so identified (by the bank, auditors, or the RBI).

Provisioning requirements: Standard assets—general provision of 0.25 percent on priority sector loans, and 0.4 percent on other loans;

Substandard assets—20 percent

Doubtful assets—100 percent on unsecured portion; provision rates on secured portion range from 20 percent to 100 percent depending on the period for which the asset remains doubtful.

Loss assets—100 percent, if remaining in the books; otherwise the entire asset should be written off.

Exceptions are made for loans to agriculture (loan is classified as substandard if it has not been paid for one or two crop seasons, depending on the purpose of the loan).
Classify loans as doubtful after 180 days, loss after 1 year.

Unify the general provisioning rate at 0.4 percent.

Introduce a category of “special mention loans” (overdue for 1–90 days, or borrower defaulted on another loan), with provisioning of 2–5 percent

Require provisioning of at least 25 percent on substandard loans, 50 percent on doubtful loans, and 100 percent on loss loans.

Large Exposure LimitsUp to 15 percent of regulatory capital can be lent to an individual borrower, and up to 40 percent to a group. With the board's approval, the limit can be raised by 5 percent in each category. Limit can be raised by an additional 10 percent (group) and 5 percent (individual borrower), if credit exposure is to infrastructure projects.Consider reducing limit for a group to 25 percent.
Connected Lending LimitsThe aggregate amount of all advances to “connected parties” cannot exceed 50 percent of Tier I capital. All advances to bank subsidiaries must be deducted from Tier I capital.Consider reducing the limit to 25 percent.
Other measuresEncourage the use of stress tests by banks themselves as well as by supervisory authorities;

Intensify surveillance and onsite-offsite inspection of potentially problem banks.

Accelerate the introduction of credit bureaus.

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Prepared by Dmitriy Rozhkov.


King and Levine (1993), Levine (1997), Rajan and Zingales (1998), and Favara (2003).


In Central Asia, average credit to GDP almost doubled over the last three years, but remains very low at around 17 percent. In many countries in emerging Europe, the level of financial deepening is also still low, especially compared to the EU levels.


Public banks in India comprise the State Bank of India (SBI) group and banks that were nationalized in late 1970s and early 1980s.


For comparison, in central and southeastern Europe, which also experienced a period of rapid growth of consumer loans from a low base, consumer loans at end-2004 were equal to 12.4 percent and 11.9 percent of GDP, respectively.


Duenwald, Gueorguiev, and Schaechter (2005), IMF (2005), Kaminsky and Reinhart (1999).


Current regulations require provisioning of 20 percent on all substandards loans (defined as 3–12 months overdue), gradually increasing to 100 percent for loans that are more than three years overdue. In the stress tests, we test the effect of introducing a more stringent requirement of 25 percent provisioning on all substandard loans, and 100 percent provisioning on all loans that are overdue for more than 12 months.


Risk weights on housing loans went up from 50 percent to 75 percent, and weights on consumer credit and capital market and commercial real estate exposures were raised from 100 percent to 125 percent, above those recommended in the Basel Capital Accord.

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