From bad loans to excess liquidity, why situation post NPA and fraud episodes is not a happy one for banks

Let us look at the standard approach to evaluating a bank, which is the CAMELS model. Suppose the bank that is being evaluated is weak on capital. This is a serious concern as future business prospects are affected when there is less capital to support it especially in light of Basel III stringent norms.

Add to this facet is weak asset quality with the stressed asset ratio being high at above 12 percent. Now the problem gets magnified as there seems to be something amiss in the balance sheet as lending has turned sour. Next, when one evaluates the management, the signs are not too good.

There appear to be governance issues here as there have been slippages along the way. Next, we look at the earnings of the bank. Here too the picture is adverse as high NPAs have made banks made higher provisions which have eroded their profits and at times the net worth.

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But what is the liquidity situation of the bank? Here the picture is better as funding is still available through deposits and when credit is not rising, the situation is under control. Besides, there is always the comfort of the bank being owned by the government.

Just when you think relief is there, the systems come apart. The systems include not just the IT structures being in place but the operating procedures which have developed chasms and above all the checks that should have been in place are weak i.e. audit.

Not when we blow up this scene of a bank to the entire public sector banking system, the true picture strikes quite glaringly. The situation is grim because a number of measures have been taken to address these issues, which though prudent, raise a broader question on credibility of the system as every response has possible negative fallout.

First, the government has made elaborate plans to recapitalise banks through various means. The issuance of recap bonds, though not the ideal way, is still looking inadequate with the new cases of fraud being revealed which will impinge profits and hence finally the net worth of specific banks.

Representational image.

Second, the IBC and RBI’s recent rules on NPA resolution show that there are time lines for everything, but this also means that if projects fail due to genuine economic reasons, there is a good chance of being pushed into the resolution process which could end with insolvency.

Third, the Banks Board Bureau that was set up for appointments has not exactly been even a moderate success and hence the issue of management remains open. CMDs are still uncertain over their tenures and would rather not take drastic decisions. It has become a habit now to blame past regimes when one takes over as the head and the cleaning up operations are even more regular every quarter.

What does all this mean? Today the situation has reached alarming levels with the recent cases of fraud eroding the credibility of lending to an extent.

The timing was awkward as it came just when it was felt that the peak of NPAs was reached and the government had found a way out on the capitalization part. The present conundrum is how one makes both lenders and borrowers feel more secure.

Bankers today run the risk of being held responsible for any loan that goes bad or fraud committed. While the amount involved in the recent case with a PSB is very high, governance issues and frauds in foreign and private banks are not uncommon.

This was observed during the time of demonetisation as well as RBI audits of banks. But such an incident in a PSB raises high levels of moralistic issues which get linked to taxpayers’ money and captures newspaper headlines. Today there is a clarion call for privatizing PSBs which is odd because frauds are committed by a few bad people which in turn is agnostic to ownership pattern of banks.

In fact the issue of privatisation is more serious as there are several questions for which there are no answers available. Is the government willing to let go of majority ownership? Is the government willing to sell at such low prices? Will the potential buyer be able to address issues of staffing and branch rationalisation without an upheaval?

Selling off PSBs weakens government programmes like Jan Dhan which have been essentially implemented by them as per diktat from above? The question now is how do we restore the faith of bankers?

From the point of view of borrowers there will be perennial fear of failure as this can lead to loss of assets at the extreme. First it will be difficult to procure loans as banks start cherry picking their customers (which is what several private and foreign banks do to ensure that they eschew risk and hence end up with low NPA ratios).

Second, once a loan is procured, there will be nervousness through the course of business as even Rs 50 crore loans are coming up for scrutiny.

This becomes even more significant when investment levels are low in the country due to limited participation from the private sector. Presently there is a deterrent for risk taking which can have a negative impact of growth in the medium run.

Therefore this episode of PSBs has posed several challenges for all the related parties. There are no quick solutions and the approach so far has been to address each issue in an isolated manner which in turn has spewed new sets of problems. While PSB bashing has become the norm from even private bankers, it appears to be unfair and does not lead to a solution. While PSBs would work with a modicum of fear of being hunted down by the CVC, CBI and CAG, borrowers too would drag their feet.

This comes at a time when the economy requires animal spirits of private enterprise to surface to accelerate growth. As finance is the key to growth, alternatives are limited. The corporate bond market is open to only the best companies while the lower rated ones which hitherto used banks as the mode of finance would find themselves in a tough situation.

At a different level a question that comes up is whether or not we had compromised our lending standards at the start of the decade by enhancing lending on investment projects that finally fizzled out which also contributed to high growth? Was that growth model not the right one in retrospect where easy money at low cost was funneled to infrastructure which finally resides as NPAs in our books? This is something worth ruminating over.

(Madan Sabnavis, chief economist, CARE Ratings, is author of 'Economics of India: How to Fool all people for all times')