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Bad loan burden: Three reasons why it's a long and hard drawn battle ahead for Indian banks

The more than 11 percent distressed asset (NPA and restructured asset) in the Indian banking system, aggregating over Rs 7 lakh crore, is a difficult problem to solve. Of course, the Indian banks have solved such problems in the past. The peak NPA of 15.7% (gross NPA as a percentage of gross advance) in 1996-97 took eight years to fall to 5.2% in FY05.

 Bad loan burden: Three reasons why its a long and hard drawn battle ahead for Indian banks


However, then the proportionate fall in NPA had more to do with the revival of loan growth mostly to large corporates which in turn was driven by revival of domestic growth. It may be argued that this time round it may not be easy for the banking system as a whole to revive in next three to five years.

There are various reasons for this. For one, loan growth is unlkely to pick up given the decadal weakness in corporate credit profiles. Close to one-third of large corporates barely earn enough operating profit to even service their interest rate. Given the strong disinflationary trend in the economy, the situation may not improve significantly in the next 18-24 months through organic growth alone.

Understandably, the banks are cautious about taking incremental exposures to over-leveraged corporates. This is reflected in the sub-10% on-year growth witnessed in overall industrial loans over the last 15 months.

As such, these over-leveraged corporates are unlikely to find any non-banking lenders who may lend them at cost effective interest rates. Thus banks and over-leveraged corporates remain married to one-another at least in the foreseeable future.

Secondly, corporates with stronger credits have started looking beyond banks. Among the 500 largest corporate borrowers, only around 80-100 corporates may currently take incremental debt without further jeopardising their credit profile. However, these corporates are not queuing up at the banks' doors for loans but are tapping the capital markets instead.

Given their better credit profile, a lot of them are able to issue commercial paper (CP) - debt security with maturity below 12 months - at rates well below base rate. The base rate for a bank is the lowest interest rate that bank can charge for any loan. CP volume shot up to around Rs 3.2 lakh crore from around Rs 1.8 lakh crore 15 months back, exhibiting more than 60 percent growth in a period when bank loan growth struggled. Some of these good credits have also tapped external borrowing at cheaper rates.

They are unlikely to bring back significant business to Indian banks unless the banks reduce their base rate. Clearly, growing their loan book to reduce the NPA rate does not look an option no matter how much the banks may like it.

Thirdly, retail indeed offers hope, but it is a tough fight out there. While the last 15 months represent the longest stretch of single digit industrial loan growth in well over a decade, personal loan exhibited a growth of 13-17 percent. Likewise, growth in the priority sector lending, though not as robust as retail loan growth has grown faster than industrial loan growth. Had it not been for the loan growth from these two sectors, which accounts for approximately 40 percent of total loan assets, the aggregate NPA rate of Indian banking system would have looked worse.

However, it may be somewhat optimistic to assume that small ticket loans would provide a way out of banks’ high NPA rate due to the tough competition in the market.

Recently State Bank of India (SBI) chairman Arundhati Bhattacharya called for consolidation of the banking sector with the objective of having four-six large banks. Previously, quite a few bankers have stressed the need for India to have larger banks as opposed to more banks.

The intense competition lead to poor adoption of risk-based pricing which may be partially responsible for the current NPA problem with respect to large corporate loans. Now with the introduction of Small Finance Banks (SFBs) the competition for retail loans and SME loans will intensify.

This may potentially deprive the existing banks of the growth which they continue to enjoy in retail and SME and other priority sector space. One may not rule out increased pricing pressure on such loans which may affect the profitability.

Fortunately for the existing universal banks, the SFBs as well as the two banks which have got new licences may require a couple of years to deploy their banking infrastructure with some meaningful scale. The existing banks may do well to keep their retail and SME banking machinery well-oiled particularly in terms of risk management and customer service. Inability to do this in next 2-3 years will make them vulnerable to onslaught from the newcomers.

The author is a visiting faculty at IIM Calcutta and a financial services professional.

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Updated Date: Nov 14, 2015 15:59:46 IST

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