Hidden NPAs bigger threat than declared ones; kudos to Rajan for calling a spade a spade

Reserve Bank of India (RBI) governor Raghuram Rajan has repeatedly cautioned banks about their penchant to hide non-performing assets (NPAs). The former International Monetary Fund chief economist has strongly warned that postponing the problem isn’t a solution. Banks should, instead, admit the stress first as the first step to solving it, he said. Part of his battle plan was bringing in norms for early identification of stressed assets in the banking system (January, 2014). As the next step, Rajan issued guidelines to stop the practice of masquerading bad loans as restructured assets. The guidelines, which came into effect from this April, takes away the benefit of regulatory forbearance offered until then on restructured loans. Banks were asked to state the actual position of bank balance sheets. On Monday, speaking at the inaugural function of Meghnad Desai Academy of Economics in Mumbai, the governor reportedly said he is facing pressure not to pursue this clean-up exercise, according to this report appeared in The Economic Times today. The report is based on a press release issued by the PR agency of the event. [caption id=“attachment_2277362” align=“alignleft” width=“380”]  RBI Governor Raghuram Rajan.[/caption] The report was actually the result of a poorly drafted press release and Rajan did not say this, a person who attended the event told this author on condition of anonymity. What is more critical here is the underlying problem Rajan is trying to highlight. There has always has been a tendency to cover up bad loans by bank managements and show a good book to investors and the promoters. The stressed asset situation in the Indian banking system is somewhat like this. Total amount of gross non-performing assets (NPAs) on the books of Indian banks at this stage is Rs 3 lakh crore. Total loans currently being restructured under the corporate debt restructuring (CDR) mechanism is Rs 2.86 lakh crore. The chunk of loans restructured under bilateral agreement between banks and corporations would be about an equal amount. Together, such assets (stressed assets) stands at about Rs 6 lakh crore or 10.5 percent of the total bank credit. More than the declared NPAs, the hidden ones are considered more dangerous since no one has any clue about the magnitude of this problem. Analysts estimate that at least 25-30 percent of the restructured assets, in the event of a delayed economic recovery, can turn bad, which is the case as of now. For years, state-run banks have excelled in the art of hiding NPAs, compared with the private and foreign banks. One major reason for this is absence of accountability of bank chiefs. The tenure of bank chiefs in public banks is short. Every retiring chairman wants to postpone NPA recognition for his successor and show a healthy balance sheet at the time of his exit. A large chunk of the infrastructure sector loans, conveniently pushed to the restructured loan book over years, has failed to recover. According to data availed from CDR, a forum of banks that takes up cases of large restructuring proposals, Rs 57,000 crore of restructured assets were tagged as failed loans, accounts that failed to recover despite recasts, at the end of March quarter, almost double from the year-ago period. What this effectively means is that the actual size of bad loans in the banking system is much more than Rs 3 lakh crore declared so far. If the fresh bad loans emerging from the restructured loans are included, the amount will be even higher. Compared with this, private and foreign banks have been more forthcoming in recognising the problem early on and cleaning up their balance sheets. In reality, however, many of the recast loan accounts were already NPAs at the time of the recast, but remained standard on the books of the banks. The facility of loan restructuring was originally conceived to lend a helping hand to genuine cases that can be salvaged with some help from banks in the form of reduction in lending rates, elongated repayment period or a moratorium. But what happened eventually was a serious mess. The infamous banker-corporate-political nexus operated in full swing. Many unworthy promoters were given recast facility despite banks knowing that these firms were stepping into deeper problems. The RBI stepped into the picture after it noticed the gross misuse of the loan restructuring facility. To get an accurate picture of the asset quality situation of a bank, one has to take into account the restructured loans. For instance, take Punjab National Bank, which reported lower slippage levels in the April-June quarter at Rs 2,800 crore from Rs 7,000 crore in the March quarter. Sequentially, the gross NPA levels have fallen to 6.47 percent from 6.57 percent. But the quantum of restructured loans on the books of PNB, as a percentage of total loans is high at 10.24 percent. This, when seen together with declared bad loans, constitutes 17 percent of the loan book. Certainly, it doesn’t offer any strong revival sign as yet. The practice of covering up bad loans has come down after Rajan took away the leeway to push bad loans into restructured basket. Banks are now more cautious. Rajan deserves kudos for initiating the clean-up exercise and daring to call a spade a spade.