Bank NPAs: The rot runs deeper and the only solution is more radical reforms

It doesn’t make sense for the government to run banks for the simple reason that it doesn’t have the fiscal ability to continue feeding the capital-starved lenders

Dinesh Unnikrishnan November 24, 2015 12:52:27 IST
Bank NPAs: The rot runs deeper and the only solution is more radical reforms

About 12 percent of Indian banks' assets are currently stressed. What this means is that for every Rs 100 they have lent, chances of getting Rs 12 back are less. The more worrying fact is that over 90 percent of this stress is on the books of the country’s state-run banks. These lenders, traditionally, have weaker autonomy in lending operations, tendency to engage in reckless lending and are more vulnerable to the corporate-political nexus.

On Monday, after a meeting with heads of state-run banks, finance minister Arun Jaitley didn’t hesitate to acknowledge the problem. “The rise in banks’ non-performing assets (NPAs) continues at unacceptable level,” Jaitley said.
The FM wants banks to clean-up the bad loan pile on their balance sheets as quickly as possible.

Bank NPAs The rot runs deeper and the only solution is more radical reforms


“But, there is no magic wand to make NPAs disappear. It is not easy,” said a senior banker, who was present at the meeting. “It all depends upon how fast the economy comes back on track, stressed assets revive and companies start paying back. Till then, the only option for banks is to avoid further lending,” said the official. That doesn’t augur well for an economy, which desperately needs funds to kick off the growth-phase.

The slowdown in credit growth is already visible.

There has been no major corporate lending in the past 2-3 years and most banks have shifted their focus to the safer retail lending to grow their books. Indian banks’ loan growth to industries shrank 1.1 percent in the first six months of this fiscal compared with a negative growth of 0.4 percent in the corresponding period of last year.

The problem

In some cases, like United Bank of India and Chennai-based Indian Overseas Bank (IOB), the level of gross NPAs has zoomed to painful proportions. IOB’s stressed loans escalated to 11 percent in the September quarter from 9.4 percent in the preceding quarter. In the case of United Bank, the RBI had to even impose a temporary lending ban on account of high NPAs.

Even bigger banks like Bank of Baroda saw a sharp jump in GNPAs to 5.56 percent from 4.13 percent in the first quarter. The only major exception to this trend is State Bank of India (SBI).

The tangible part of the bad loan pain on the government banks and, in turn, on their owner (the government) is the immense capital burden.

The estimated (moving) capital requirement of India's state-run banks to meet the Basel-III norms over the next five years is about Rs 2,40,000 crore. Incidentally, that’s only a tad less than the GNPAs of India's 40-listed banks (Rs 300,000 crore), most of which are on state-run lenders' balance sheets.

To this, add the capital implications arising out of higher provisioning burden of the government banks on the stressed assets pile (bad loans plus restructured loans), the cumulated burden can offer Jaitley sleepless nights.
Jaitley got the bank capitalisation strategy wrong from the very beginning, when he earmarked just Rs 11,200 crore to meet banks' unending need for cash in the Union Budget.

After much persuasion from the RBI, Jaitley later agreed to increase the capital infusion to Rs 70,000 crore. But, experts say even that is too little.

“The government is now batting like Sehwag without seeing the ball,” said Abhishek Kothari, equity research analyst at Anand Rathi Securities. “On the one hand, they need PSBs to clean up their balance sheets, on the other aid growth through increased lending. A steroid injection so late won’t help in quick healing,” Kothari said.

The bad loan scenario of Indian banks hasn’t improved significantly in the recent years on account of three factors. One, the revival in the investment cycle hasn’t taken strong hold yet. And the second, the process of rebooting of the delayed projects hasn’t yet translated into improved cash flows for companies.

Does the Modi government have the wherewithal to fulfil its commitment towards India's state-run banks? Experts are doubtful on account of its fiscal constraints.

State-run banks’ capital requirement appears to be well beyond the capacity of the government coffers, especially when the fiscal situation doesn’t look healthy with higher cash out go if the 7th Pay Commission proposals on compensation to public sector staff and pensioners are accepted. Especially since revenue from corporate tax collection is likely to decline. The government’s ability to raise funds from divestment is critical.

How did the NPAs pile up?

It didn’t happen overnight.

Besides the overall economic slowdown, one major reason why the NPAs shot up is the reckless lending resorted by state-run banks, between 2008-09 to 2011-12, without adequately assessing the risks. The focus was on volume growth and not quality, said the banker quoted earlier.

“It was high competition that was driving the credit operations and not prudence. The idea by every bank chairman appeared to grow the loan book as quickly as possible by sanctioning large ticket loans and not the quality of assets. The hope was an economic boom, thereafter, which never happened,” the banker said.

Adding as many zeroes in their total business numbers and advertising it on the mastheads of national newspapers have become an annual ritual for India's public sector banks, more of an exercise aimed at appeasing the political bosses and ensuring a post-retirement berth, rather than giving a true account of business to the shareholders.

Secondly, interested party lending and the role of middlemen played a key role. The banker-middleman-corporate nexus operated in full swing. Most often than not, these interested parties are those linked to influential politicians and business groups.

There have been several occasions, which bankers typically fear to say in the open, when they have received informal missives from ministers to lend to a particular company, wherein that minister has some interest. Middle-level bank officials at state-run banks often succumbed to such pressures

Third, a new set of promoters, who wouldn’t pay back loans to banks despite having the ability to do so emerged more often. The RBI called them wilful defaulters. Once a company or promoters is tagged as wilful defaulter, no other financial institution will lend to such parties, nor can these promoters be part of any other organizations.

The latest such case is liquor baron, Vijay Mallya, whose grounded airline, Kingfisher, owes over Rs 7,000 crore to some 17 banks. Recently, SBI classified Kingfisher and its guarantors as wilful defaulters after a prolonged legal battle. Other banks too are likely to follow the suit.

As per the data obtained from the All India Bank Employees Association, there are 7,035 cases of wilful defaults with a bad loan pile to the tune of Rs 58,792 crores as on 31 March, 2015.

Fourth, bad loan picture turned grim after banks started pushing loans to the restructured category to prevent them becoming NPAs. This only postponed the problem and started to backfire. Many of these loans were close to NPAs when they were admitted to recasts.

This practice, however, came to an end when the RBI withdrew special regulatory dispensation for rejigged loans, forcing banks to treat newly restructured loans on par with bad loans.

The chunk of fresh NPAs emerging from restructured loans have been on the rise since many such accounts failed to revive. Banks did this cover-up largely in the infrastructure sector. On a conservative basis, about Rs 6 lakh crore loans are currently being restructured both under the CDR channel and on a bilateral basis.

Under the RBI norms, for every loan that turns bad (when dues remain unpaid for 90 days or more), banks have to set aside money in the form of provisions. This ranges from 20 percent to 100 percent of the loan value, depending on how bad the state of the underlying asset is.

That means if a Rs 100 loan goes bad to the loss category, the bank needs to set aside Rs 100 from its kitty to cover that loss. If the loan is restructured, the provision is 5 percent of the total value. Such high provisions make additional capital a must for banks.

The solution

A slew of corrective measures initiated by the Modi government such as cleaning up the power discom mess with state-supported revival package, increasing the tenure of bank chiefs and creation of a bankruptcy code can aid the reduction in bad loans over a period of time.

But, the actual implementation of these promises is critical, says analysts.

“Measures such as bankruptcy law and strict action on wilful defaulters may aid in lowering NPAs,” said Kothari of Anand Rathi Securities. “But, despite the promise of doing necessary steps in power and other stressed sectors, nothing has happened in the one and a half years,” Kothari said.

Also, as Firstpost noted yesterday speedy judicial resolution of cases involving large-ticket bad loans is critical for banks to recover their dues. Many a times, after long years of litigation, the sharp erosion in the value of underlying asset leaves nothing much for the lender to recover.

It is also crucial for the Modi government to give a serious thought to privatisation of government banks. So far, this government has shown an aversion to the privatisation of banks.

It should learn from the experience of the private sector banks and show the guts to moot radical reforms in the banking sector by privatising state-run banks. Arguably, the two-stage nationalisation of state-run banks has clearly failed to achieve the desired impact and its time for the government to exit the business of banking and focus on governance.

It doesn’t make sense for the government to run banks for the simple reason that it doesn’t have the fiscal ability to continue feeding the capital-starved lenders, especially in the backdrop of high stress on their balance sheets.

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