Two developments in the area of banking which should raise the antenna are in the areas of NPA resolution and loan waivers. Both of them have similar undertones as they deal with loans that cannot be repaid, though the story to the build-up of the same has been different with the former having ‘history’ while the latter is more ‘contemporary’. They need to be looked at carefully because both can be repeated which will vitiate the idea of banking in the long run as the system which includes funds dealt with as well as lending standards get slippery.
Let us look at NPA resolution first. There has been a lot of hype over the resolution of the issue with the IBC being invoked. The RBI has also set up an oversight committee which will initiate the process with 12 accounts to begin with. The stock market has reacted more than positively which is alarming because bank stocks have risen at a time when their future looks less encouraging given the costs involved as the resolution process unfurls.
Two things need to be considered here. The first is that it is time consuming and one is not sure of when the story will end because what has been created right now is a road to resolution with the policemen in place. But can this volume of debt involved be addressed by the systems with consummate ease or whether there can be breakdowns along the way is anyone’s guess.
The other point is that even as these cases get resolved, the cost has to be borne by someone and it is not that money is being generated from outside to write-off these assets. To the extent that the assets are sold to a third party (which is not happening today out of fear of reprisal), there could be some recovery in terms of payment made. But the balance haircut which becomes due once the decision is taken by the joint lenders forum (JLF) or in the ultimate instance insolvency invoked, has to come on the books of banks.
The paradox here is that even as these cases get resolved in the next 180-270 days or more (in case the courts cannot take it up or the borrowers are able to prolong the cases through appeals), the concerned banks will continue to be under pressure as their P&L accounts will be moving towards the negative region due to provisions or write-offs which also means that their valuation in the market will get affected. This is against the present trend of euphoria in bank stocks which is a result of the expectation that the NPAs will be resolved. But as can be seen, any resolution will result in an actual loss for the bank on their books.
This, in turn, has deeper implications for the PSBs in particular which have to be recapitalised. Capital can come from government allocations in the budget or through government stake sale in the market. The government does not appear to be willing to go beyond the allocations made in the budget and in the current uncertain state of finances given the GST impact it is unlikely to be very different this year. This means that the government has to lower its stake which is not possible as long as the banks keep making losses.
Therefore, the NPA resolution process is just the start of the series of challenges that banks will have to practically face which has been brushed under the carpet so far as there were no feasible solutions available. One must remember that finally someone has to pay for these bad assets, which will come from the deposit holders’ funds.
It is also significant that the decision of several states starting with Uttar Pradesh, Maharashtra, Madhya Pradesh and Karnataka (and probably more in the pipeline) to go in for loan waivers. It is a parallel decision taken to address such issues on NPAs in the agri space. The issues with any farm loan waiver scheme are well known - adverse selection, moral hazard and fiscal strain etc.
The argument in support is always on the emotional side that if we can forgive loans taken by industrialists, then by the same yardstick, farmers should get the benefit as they deserve it even more. As the funds are coming from the government and the banks as such do not lose money (provided they are paid on time which is not usually the case), there is prima facie no direct impact on the banking system.
But, the cost finally is paid by the public as the revenue collections of the states are used for making such disbursements and as stated earlier, there is no free money anywhere. This is a cost imposed on society at large, which raises a broader question for the banking sector. Are we actually compromising banking standards here when loans forgiveness which is driven by motivations of either humanism or desperation, actually leads to dilution in lending standards which dents the credibility of the banking system.
Financial systems are the most integral part of any economy as they facilitate transactions by channeling funds from surplus segments to those which require funds for productive purposes. With a stressed assets ratio of around 11-12%, quite clearly the system has not put on a good show as these assets have built up over a period of 7-8 years as these defaults do not happen immediately. By creating a culture of inertia when it comes to debt-servicing, the message sent out is that at the end of the day there will be support coming from the government in some form to ensure that the system does not collapse.
This is not a good sign which is why one cannot be ecstatic of the NPA resolution process or the farm loan waiver which is paid out by the government, as the foundations of our banking system are being weakened by such acts. Hopefully, we would learn from these episodes and lower the probability of repeating such conscious errors in future.
The author is chief economist, CARE Ratings. Views are personal
Updated Date: Jun 23, 2017 11:09 AM