RBI report shows Raghuram Rajan’s 'Swachh Banks' mission is working

The Reserve Bank of India’s (RBI) financial stability report (FSR) is a timely reminder to the Narendra Modi government about the critical nature of the ‘Swachh Banks’ mission initiated by outgoing governor Raghuram Rajan to clean up the bad loan mess in the country’s banking system. Much dirt has already been dug out from under the carpets of public sector banks (PSBs) in the last two quarters when a significant part of the restructured loans were classified as Non Performing Assets (NPAs). There is more to come. There is no prize for guessing why banks, all these years, never bothered to show NPAs as NPAs and preferred to call them restructured loans. [caption id=“attachment_2862006” align=“alignleft” width=“380”] Raghuram Rajan. PTI[/caption] The sharp spike in NPAs as reported in the FSR report essentially confirms that the surgery initiated by Rajan is working well. A substantial decline in the portion of rejigged loans and increase in bad loans means only one thing: Many of the corporate loans banks pushed to the restructured basket in yesteryears were actually bad loans. The deadline set by Rajan to finish the clean-up exercise (March 2017) forced banks to roll up their carpets to expose the muck collected over the years. The extent of exposed muck poses a big challenge for Rajan’s successor who has to oversee the cleanup till the end. The Modi government would do well to ensure the continuity of this exercise. Here’s the broader NPA picture that the FSR offers. Total gross non-performing assets (NPAs) in the banking system have escalated to 7.6 percent of the loans in the March quarter from 5.1 per cent in the September quarter. In the worst case scenario (if things don’t do well in the economy), the total NPAs could rise to 9.3 percent by March 2017. With that, the total stressed assets (bad loans plus restructured loans) in the banking system have marginally risen to 11.5 percent of the total loan book compared with 11.3 percent in September. Logically, public sector banks (PSBs) continue to hold the highest level of stressed advances ratio at 14.5 per cent, whereas, both private sector banks and foreign banks (FBs), recorded stressed advances ratio at 4.5 per cent. But, as highlighted in the beginning, one has to see these numbers in the context of a decline in the restructured assets of banks, which fell to 3.9 percent at the end of March quarter from 6.2 per cent in September. What this essentially means is that most of the restructured loans have been shifted to the NPA book, finally. This gives hope that the era of merrily masquerading bad loans as NPAs will soon be a thing of the past. The reason for marginal increase in total stressed asset levels despite sharp rise in NPAs is the simultaneous sharp decline in restructured loans. The credit for this goes to Rajan for kicking off the bad loan clean-up exercise risking the wrath of the industry experts like HDFC Chairman Deepak Parekh, who said deep surgery could make banks comatose. The whole exercise acted like a shock treatment for the banks forcing them to declare NPAs in truckloads from their balance sheets that were piled up for years. In the last three months alone, banks have declared additional bad loans worth Rs 2 lakh crore. Subsequent to Asset Quality Review (AQR), the banking sector GNPAs showed a sharp on-year increase of 79.7 per cent in March 2016. Though this clean-up will result in significant jump in bank NPAs in the short-term, especially for state-run banks, it will reinstate the credibility of bank balance sheets, necessary for their survival in the long-term. That is precisely why Rajan has been weighing in on banks not to postpone the problem for tomorrow and worsen it. This exercise also meant fight against cronies since there have been a covert understanding between banks and large corporations. Corporate loan problem The FSR report also highlights the magnitude of problem caused by the large corporate loans. The gross non-performing asset (GNPA) ratio of large borrowers rose sharply from 7 percent to 10.6 percent during September 2015 to March 2016 and the increase was evident across all bank groups. Here again, state-run banks recorded the highest at 12.9 per cent. Top 100 large borrowers (in terms of outstanding funded amounts) now account for 27.9 percent of credit to all large borrowers and 16.2 percent of the credit of all banks. There was a sharp increase in the share of GNPAs of top 100 large borrowers in GNPAs of all large borrowers from 3.4 percent in September 2015 to 22.3 percent in March 2016 reflecting again reclassification. But there is good news too. There is a slight improvement in the balance sheets of the corporate sector. The ratio of overleveraged companies (with debt-to-equity ratio over 2 per cent) has come down in RBI’s sample, so have their debt levels. This is Rajan’s last financial stability report before he steps down in September. Now the critical question is whether Rajan’s successor will take up the onus of completing the bad loan clean-up exercise in its true spirit or succumb to the pressure of the crony-political nexus. The task is tough since there is lobbying on the part of cronies who were forced to either pay up banks or pack up and leave after Rajan commenced the exercise in mid-2015. Also, there is a certain amount of pain for the government too (which it wouldn’t want to acknowledge openly) on account of the huge capital implications associated with the exercise. On 10 June, in a note, rating agency, Moody’s Investors Service said that the government will have to infuse Rs 1.2 lakh crore into state-run banks by 2020 to bolster their balance sheets and make good the losses suffered by them. This is way higher than an additional Rs 45,000 crore capital infusion plan envisaged by the government. It is doubtful whether Finance Minister Arun Jaitley can find the means to bridge the funding gap in PSUs in the aftermath of the bad loan cleaning. Banks are required to set aside money in the form of provisions. What Jaitley has earmarked so far is too little considering the capital needs of PSBs, which desperately need capital to make provisions on bad loans, fund future credit growth and meet Basel-III norms. The only long-term solution to salvage state-run banks is to let private capital come in. The government will, eventually, be forced to rethink its aversion to privatization. Equally worrying is the fact that as long as the stress in the banking system remains high, the credit cost for corporate borrowers, including small and medium companies, will remain on the higher side. This will create further road blocks on the path to economic recovery. Only top rated companies are capable to tap money markets to raise cheaper funds. The majority rest will still have to depend on bank loans for survival. The bottomline is this: the muck is finally coming out of bank balance sheets, probably for the first time on such scale. That’s the good news in the bad news (of rising NPAs). Rajan’s continuation for another term would have ensured that the bad loan clean-up exercise would remain on course. One can’t be too sure about whether his successor will continue the exercise in full earnest. The FSR report is the best reference guide for Rajan’s successor to study the bad loan problem and hit the ground running. Data contributed by Kishor Kadam