As the proportion of non-performing assets (NPAs) of public sector banks grows, the banking system is struggling to keep its bottomline, impacting new lending and consequently, the economy.
The Reserve Bank of India (RBI) estimates that banks have accumulated non-performing assets of Rs 17 lakh crore for the year ended March 30, 2019. Of this, public sector banks had a share of Rs 8 lakh crore.
The problems with NPAs have been mounting for the last five years, affecting overall economic growth. Despite a huge capital infusion into public sector banks, the system has struggled to improve its performance. Owing to the general slowdown in economic growth, the GDP growth has come down from a high of 7 plus per cent to a worrying 5 per cent in the last quarter.
The International Monetary Fund (IMF) has ranked India at 33 out of 137 countries (in descending order) on the bad loans front. India with a gross NPA ratio of 10.3 per cent in the quarter ending September is slightly better than Russia’s 10.7 per cent whereas in large economies like the UK, the NPA stands at just 0.81 per cent and the US has an NPA ratio of 1.13 per cent (See graphic).
In India, if a borrower fails to pay interest or repayment of principal amount to banks for over 90 days, the amount is classified as an NPA, after which the banks will have to provide for NPAs in their balance sheet.
Earlier, banks did everything they could to avoid classifying loans as NPAs. The business-politics nexus helped their cause. Banks then simply restructured loans and called them ‘evergreen’ or gave a fresh loan to repay the old loan or gave a new loan to one of the promoters’ group companies.
In 2015, the then RBI governor, Raghuram Rajan, took a firm stand to clean up the Indian banking system and put an end to this unhealthy practice. He initiated the Asset Quality Review (AQR) system that compelled banks to make a provision for bad loans in their balance sheets. PSU banks started bleeding after implementing AQR. In 2015-16, they incurred a cumulative loss of Rs 17,996 crore; in the following year, it reached Rs 1.80 lakh core. In 2018-19, it ballooned to Rs 8.06 lakh crore. Private banks, too, were affected due to demonetisation, easy loans for large infrastructure projects that went bad, and a general slowdown in the economy.
Quoting the RBI, a Finance ministry note attributed the primary reason for the spurt in stressed assets to aggressive lending practices, wilful default, loan frauds, corruption in some cases, and economic slowdown.
Madan Sabnavis, Chief Economist, CARE Ratings, said, “The high NPA ratio is due to the combination of many factors. When the economy was growing at a faster pace, huge infrastructure projects in power, steel and coal were funded.” These projects are incomplete or have been stopped due to business reasons, unexpected global development and many other factors. The slump in economy made it difficult for companies to perform and they defaulted on repayment.
Wilful default, Sabnavis said, is a ‘criminal’ offence that must be tried under the Insolvency and Bankruptcy Code.
A recent study on the rise of NPAs in India by economist Ahita Paul showed that a number of loans currently classified as NPAs originated in the mid-2000s at a time when the economy was booming and business outlook was positive. Large corporations were granted loans based on extrapolation of their recent growth and performance. With loans being available more easily, corporates relied on external borrowings rather than internal promoter equity. But as economic growth stagnated following the global financial crisis of 2008, the repayment capability of these corporations decreased considerably.
While in general, technological changes, global market turmoil, the geopolitical environment and government policies tend to impact businesses, in India, businessmen with political patronage borrow with no intention to pay back. They divert funds for their personal use. Defaulters like Kingfisher, Bhushan Steel and many other well known companies piled up huge bad loans in this way.
To tackle the rampant malpractice, the government came out with a bankruptcy law to strengthen the corporate sector and weed out inefficient and defaulting companies from the system. The Insolvency and Bankruptcy Code (IBC) aimed to consolidate the existing framework by creating a single law that gives an exit route to defaulting companies and individuals who are unable to repay their outstanding debt. The law was further amended in 2019, further streamlining it.
Major corporate debtors like Bhushan Steel, Essar Steel, Electro Steel, Jyoti Structures, Lanco Infrastructure, Era Infratech, Jaypee Infratech, Alok Industries, Bhushan Power & Steel, Monnet Ispat, ABG Shipyard, Amtech Auto and Videocon have been referred to IBC. A few of them have partially recovered NPAs. But again, a majority of them are using delaying tactics.
In its report, ‘Banking Sector in India – Issues, Challenges and the Way Forward’, the Parliamentary Standing Committee on Finance chaired by former cabinet minister M Veerappa Moily observed that high volumes of NPAs have eroded the capital base of banks and restricted their ability to lend. The problem of high loan write-offs and NPAs, combined with low asset growth, is more severe for public sector banks than private banks.
RBI’s minimum Capital to Risk-weighted Assets Ratio (CRAR) – a ratio of a bank’s capital to its risk taking capacity - at 9 per cent, is on the higher side. It is one per cent higher than the globally required CRAR under the Basel III norms that govern global banking. The norms are applicable to all PSBs, even though nine of them do not operate internationally.
The committee said relaxation of high CRAR requirement would release capital of Rs 5.34 lakh crore. With this, loans will grow and generate an additional Rs 50,000 crore of income annually, and that will eliminate the need for further capital infusion. It also stated that once most of the larger NPAs get resolved as per the IBC or other mechanisms, the situation will become better for the PSBs.
Banking experts say that the ideal NPA rate for a fast growing economy like India is 3 to 4 per cent; it can go up to 6 to 7 per cent at a certain point of time. But above 10 per cent is an unhealthy and intolerable level.
Is there any ready-made formula to reduce the NPA at a reasonable level? “Ensure that all processes are in place and don’t allow any interference from any quarters. Incrementally, make sure to be more careful about lending,” said Sabnavis. For the existing NPAs, he suggested that wherever viable, the banks should go for restructuring. If not, it should take the IBC route. “There will be some recovery. That is the only way to go about it. A recovery of 40-50 per cent is possible,” he added.
A study on banking crisis titled ‘Good Bankers to Bad Bankers’ by the Economic Development Institute of the World Bank suggests that regulation and supervision are not panacea, but are necessary pillars for a strong financial system and limit damages caused by mismanagement and make macro policies effective. Good regulation and supervision may prove to be no good if there are no mechanisms in place to solve insolvency cases.
India can fit into this template – better regulations and a solid framework for insolvency. India needs an autonomous central bank and corruption-free environment that says a strict no to political interference, to bring its NPAs to a globally acceptable level.
- News Research Department