The announcement of the bad assets scene by banks for December quarter, especially those of PSBs, has sparked varied emotions ranging from disbelief to disdain. The PSBs have all been hit with higher NPAs and more importantly, have made higher provisions for the same thus leading to decline in profits.
This is probably the first time that such an operation has been conducted which has in turn cast a shadow on their working. So much that critics are questioning the governance standards in these banks and looking for askance from the government for capital to revive them. What really is the true picture and is there a solution?
The issue of NPAs has to be looked at from four corners. These are the stage of loan sanction, monitoring, recognition and redress. To begin with it must be understood that any kind of lending involves risk and the idea of having an intermediary is that it is better placed than individuals to assess the same. However, as banks are trusted with public money they have to do a good job and cannot slip-up due to carelessness or any other pressure. Unlike other commercial enterprises which are run on debt and equity, banks run on public money which has to be guarded.
The increase in NPAs has been due to a variety of reasons which include economic slowdown, incorrect assessment at the time of sanction, cronyism, differential accounting standards and focus on lending targets. It is probably right that we are cleaning the system presently as it will make the system stronger.
The first important aspect of quality of assets is the initial stage of credit appraisal. This is critical because often errors come in at this stage. The choice of portfolio is important. Some banks especially in the private sector have followed models where the focus is on retail portfolio and hence have taken on a less risky option. PSBs invariably ended up with the infra projects either out of choice or were goaded to do so by various governments.
Prima facie, there did not appear to be anything amiss when the economy did well and the lending went on progressively and the quality of assets was stable. Further, with the government being the owner, there was actually nothing amiss in ‘interference’. However, when the commercial aspects hit the operation of banks, such interference has been brought to the fore. The 5 sectors which have accounted for the bulk of NPAs have been infrastructure, mining, textiles, steel and aviation. Quite clearly a professional approach is required to make the system robust.
The second aspect of such loans is the monitoring part, where banks need to follow up regularly and track the assets. Further, the state of the economy as well as industry has to be constantly on their radar to gauge the dangers that lie for the company concerned. For example, when we see steel prices falling, it is a signal that has to be picked up by the lender and the entire portfolio has to be examined in this sector.
Such warning signals are often not paid heed to. And what is more dangerous is that the same sector keeps receiving more funds from the banks. There is of course an ideological issue of at what stage should a bank stop lending as the line dividing when it should support and when it should withdraw is quite thin. The problem is that lending becomes mechanical where there is little application besides meeting targets and probably diktats from the top.
Third, the regulatory aspect is important. While banks have been chided for not treating NPAs correctly, the ball is really in the regulator’s court. Should the concept of restructured assets be permitted to begin with? If it was not, then this problem would not have mounted to such an extent.
Similarly, while banks have been found to be not treating assets as NPAs when it was being serviced for them while other banks were not being paid on time, the question really is why did the auditors allow such a practice? While delving into the past is not really a solution, the way ahead is to have clear ways of defining a NPA.
Restructured assets were always called ever-greening by critics which was reminiscent of the eighties and nineties. While an explanation was given that such projects failed because of extraneous conditions, does not this hold for most failed loans which are not caused wilfully? Therefore, the way out is to have clear regulation which should be followed by all banks so that the true picture comes out. While we have been talking of stressed assets for long – sum of NPAs and restructured assets, we have not done much to recognize the same.
A corollary is that once recognized provisions should be made mandatory so that banks keep buffering themselves from the eventuality of the asset having to be written off. Further, to ensure that everyone gets involved including the government for PSBs, dividends paid should be linked with NPAs. This way the temptation to direct bank credit would also get diluted from the government’s end.
The last part of the story would be dealing with NPAs once they have been recognized and provided for. The bankruptcy code would hopefully be passed which will address the issue for banks to a certain extent. Creating a bad bank as was done after the Asian crisis is an option but given that the asset reconstruction companies that have been in operation have not been adequate to actually take over assets and sell them, one is not too sure if this will work well.
Besides these four steps that need to be taken, we also should have a system that provides warning to banks. First, the list of chronic defaulters has to be made available to banks so that they should cut down their exposures. By cutting them out of the line of bank credit, it can be a deterrent. This kind of information dissemination will automatically help banks in recognizing NPAs. Second, the RBI should regularly highlight the sectors that have such NPAs so that banks can plan their exposures accordingly. Information dissemination is absolutely important so that correct decisions are taken.
The high level of NPAs today in the system should ring a bell to both the banks and regulators. It should be used to cleanse the system and provide the blocks for a stronger banking system with prudent regulation. This is important also because once the economy recovers and bank credit picks up, there would be tendency for credit appraisal norms to slip, as the euphoria normally justifies taking on higher levels of risk. It happened earlier when easy money and high growth convinced us that the bull run will continue. We should certainly not fall for it, when we move up the business cycle again.
The writer is a chief economist at CARE Ratings, and his views are personal.