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The 6 lakh crore problem that's dragging our economy down


Ballooning non-performing assets (NPA) of banks are fast becoming a millstone around the neck of the sputtering Indian economy. The sectors which have the highest NPAs are aviation, textiles, telecom, power, infrastructure and mining sectors, owed mostly to government owned banks. Even if 50% of the over 6 lakh crores of NPAs are to be finally written off as is expected, that's equal to the size of the country's annual fiscal deficit - which means recapitalizing banks to that extent is not going to happen in a hurry. Seeking to remedy matters, the government has empowered the RBI to take steps as it deems necessary to deal with this pernicious issue.

Dimensions of the problem

By December 2016, according to a parliamentary reply by Mr. Gangwar, Union Minister of State for Finance, bad loans had surged to Rs.6,06,911 crores from Rs. 2,67,065 crores at the end of FY 2014-2015. "The Government has taken sector-specific measures (power, road, infrastructure, textiles, steel etc.) where incidence of NPA is high," Gangwar said. (Thenewindianexpress 15 March, 2017)

Of the 4.33 lakh crores (as of June 2016) loans to the basic metal and metal products sector, fully 1.49 lakh crores has become bad. About 17% of the loans advanced to the textiles, tobacco and beverages sectors have become bad.

An even more alarming piece of statistic shows that 40% of total advances are owed by companies with an interest coverage ratio of less than one (Credit Suisse). RBI's December Financial Stability Report, reveals that large borrowers (defined these as debtors to whom lenders have an exposure of at least Rs 5 crore) account for 56% of bank debt and 88% of their NPAs. Making the picture even bleaker, the IMF says that Indian banks might have to set aside three years' earnings to provision for existing bad debts.

Causes for bad loans

It would be easy to enumerate several causes for bad loans, such as crony capitalism, a struggling global economy, excess production capacity and reduction in output prices, collapse of commodity prices, regulatory delays and corruption in infrastructure projects. However these are not the only causes. There is a big capability deficit among banks, mainly public sector banks to assess and mitigate credit risks.

Competition has driven some banks to make dubious loans without undertaking proper analysis of the creditworthiness of the borrowers. This has been exacerbated by a certain 'herd' mentality, when bankers rush to lend to parties who have borrowed from bigger banks. Many banks have mispriced infrastructure loans. Cheap long term loans are the least likely to be repaid, since enterprises have little financial incentive to settle long term loans bearing low interest rates.

"One reason for bad loans is that many promoters feel that it is not a good idea to do business with one's own money. They tend to divert funds from the day a loan is sanctioned and released," said S. Santhanakrishnan, CA, and former Chairman of Catholic Syrian Bank, in an address to the Institute of Cost Accountants at Chennai on 14/5/2017. "Banks should move to a system that while being anchored in security based lending, also takes cognizance of the importance of cash flows," he said.

Short term Solutions

The short term solution seems to lie in creating a new institution which would take over the bad loans and take steps to recover the amounts. This would free banks from the headache of dealing with this complex problem and get back to the business of lending. However, the pitfall is that a public sector 'Bad Bank' may not perform as desired, thus allowing the problem to fester.

Wider reforms

Long term solutions will have to be found in a broad spectrum of measures to address all issues affecting banks. Reorganization of banks, the management structure and business models must be undertaken. Most public sector banks lack technical competence to undertake the serious due diligence to vet large loans. Bank boards must accept greater responsibility for setting policies and for creating an ambience of professionalism. It must be understood that while regulators can raise red flags, it is the bank boards that should play a pro-active role in detecting and dealing with NPA issues in a forthright manner. They must also insist that promoters bring in their own money as equity contribution rather than through raising further debt.

Banks must undertake deeper stress analyses incorporating longer and more volatile business cycles. Banks must develop a comprehensive Management Information System to monitor loans. Further, these institutions must carefully monitor performance of loans and develop sound methods for loan appraisal including for consortium loans. There must be early warning systems to warn banks of nascent NPAs.

"No loan becomes sick overnight," said Mr. Koteeswaran, former Chairman of the Indian Overseas Bank at the meeting on 14/5/2017. "There are always many signals, which either go undetected or are simply ignored."

RBI's moves

An RBI panel says that loan accounts with outstanding amounts of Rs. 5,000 crores, of which at least 60% is classified as NPA can be referred for bankruptcy proceedings. Demonetization seems to have affected the ability of many small and medium enterprises to service their loan obligations. Currently bad loans stand at Rs. 614,872 crores or 11% of the gross advances of Public sector Unit (PSU) banks. In all, the total NPAs including both the public and private sector banks were Rs 697,409cr in December 2016. (Financial Express May 17, 2017)

"While presently published statistics put NPAs at about 10% of the loan portfolio, the reality is that it is likely to be nearer 30%," Mr. Santhanakrishnan said.

Final Say

Wouldn't privatization of publicly owned banks improve their performance? Is anybody thinking about this at all? It is noteworthy that private sector banks have not been affected to the same extent as public sector banks. Tellingly, in December 2016, bad debts of private sector banks were just Rs. 70,321 crores out of a total NPA of Rs. 6,06,911 crores. Private sector accounts for about 30% of the banking industry.

The NPA problem is big enough to destroy many banks, already teetering on the edge of negative net worth. Yet unless the banks recover their financial health, the performing sectors of the economy would be starved of credit to carry on their legitimate business. If, optimistically, banks have to write off just 50% of these loans it would amount to a whopping Rs. 300,000 crores or more. This is roughly the fiscal deficit in the current year. Obviously recapitalizing banks on this scale would be difficult and long drawn out if not impossible.

Again, the new move by the government to empowerthe RBI to resolve NPA issues raises as many questions as it seeks to answer. Can the RBI play both the role of a regulator while getting involved in administrative decisions on bad loans? Isn't there a conflict of interest here? Only time (of a short nature) may answer these questions.

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