Battling NPAs

In a recent email sent to the staff at the Reserve Bank of India, its Governor Raghuram Rajan made a stern and uncomfortable observation about Indian culture. “No one wants to go after the rich and well-connected wrongdoer, which means they get away with even more,” Rajan wrote. “If we are to have strong sustainable growth, this culture of impunity should stop.” Apply these comments to the Indian banking system, and one has the answer to the rising levels of bad debts or non-performing assets (NPAs). Suffice to say, the bad state of banks, especially those in the public sector, continues to get worse as time progresses. According to the Financial Stability Report (FSR) released by the RBI, the NPAs of the banking system amounted to 5.1 percent of the total loans given by banks as of the September quarter from 4.6 percent in March 2015. It is a massive jump of 50 basis points in just six months. However, the figure of 5.1 percent does not capture the gravity of the problem. Many recent studies point to how banks have used various methods to delay the recognition of bad loans. In other words, banks have given more time or better terms to the borrower to repay the loan, among other methods. In banking parlance, such loans are often referred to as restructured loans. Unfortunately, the recent RBI report indicates that the option of restructured loans, among others, have been abused by the banks, despite prior warnings. As a recent editorial in a business newspaper notes, “The decision to restructure a loan was supposed to be a technical one, taking into account the viability of the borrower. But in the case of government banks, the decision to restructure has often been influenced by political considerations, and has depended on the clout of the concerned promoters.” It is no surprise, therefore, that NPAs in public sector banks, according to the RBI report, stand at 6.2 percent of total loans as of September 2015 quarter. Restructured loans, meanwhile, stand at 7.9 percent. But many loans that were restructured in the past are now NPAs. According to another recent study, the failure rate, or the rate at which restructured loans are defaulted on, has grown from 24 percent to 41 percent over the past two years.

It’s no secret that India’s top conglomerates have been under immense financial stress, despite their attempts to cut debt by selling assets and cutting capital spending. According to a report by Credit Suisse Group, a leading global financial consultancy firm, the total debt at the top 10 most indebted groups has risen seven times over the past eight years and such a sum adds up to 12 percent of the loans in the banking system and 27 percent of corporate loans. They account for a major fraction of the banking sectors credit extended. Loans of companies such as Deccan Chronicle, Kingfisher Airlines, Essar Steel, amounting to a whopping Rs 30,000 crore have gone bad. Quite clearly, the banks that have been generous with credit are those mainly in the public sector. No professionally managed private bank would lend so recklessly. This is the consequence of “social control” of banks, which neither the Modi government nor the previous UPA government has been able to resolve. As stated earlier, vast sections of the political class from either side of the “ideological” divide continue to feed this debt-fuelled mania. Bad debts have come in like a wrecking ball and hit the Indian banking system hard.

The central bank has a tough task ahead to ensure that the financial health of public sector banks (PSBs) does not deteriorate further. On way to deal with the problem is that the sanction of big loans should be outsourced to a group of professionals who should be directed to follow the appraisal process practiced by leading private sector banks. In fact, the top management in PSBs should not hesitate to approach their private sector peers to learn the best management practices. The RBI’s circular called a Strategic Debt Restructuring Scheme issued to all scheduled commercial banks is a step in the right direction. It suggests several manifold solutions to the looming crisis. In some cases, defaulting borrower companies may not be able to come out of stress due to operational/ managerial inefficiencies despite substantial sacrifices made by the lending banks. In such cases, change of ownership will be a preferred option.  Although these are some of the steps in the right direction, a lot more needs to be done.