The banks are the lifelines of the economy and play a catalytic role in activating and sustaining economic growth especially for growing economies like India. The emerging economies are facing financial instability due to domestic imbalances, weak global demand and rising trade protectionism in the advanced economies. And since the onset of the Financial Crisis in 2008, the global economy has continued to face rough weather and the Indian economy and our banking system have not remained immune. In order to spur economic growth, the central banks around the world have been employing various techniques such as quantitative easing, near zero interest rates and liberal monetary policies but they have failed to reach the pre-recession levels.
The Indian Banking Sector have largely protected itself against external imbalances owing to robust monetary policy and persistent hawkish stance taken by the Reserve Bank of India. But our banking sector is marred by domestic challenges. The financial distress that it finds itself in is largely owed to their extensive exposure to sectors having tepid growth from a long time, namely infrastructure, metals, textiles, chemicals, engineering and mining. The large public sector banks account for a high percentage of lending to these sectors.
The distress in the Indian Banking sector was largely accentuated by the Asset Quality Review by Reserve Bank of India in 2015-16 to gauge the health of Indian banks and cleaning the balance sheet of banks. Complementing the Annual Financial Inspection, this reported suggested approximately 200 accounts which may be bad loans. Since then the banking sector is struggling to meet operational and credit obligations.
As on March 2017, the banks are sitting on a pile of total stressed assets of approximately 10 trillion rupees. This accounts for nearly 12% of the gross lending from banks. According to the S&P Global ratings, the stressed assets in Indian banks are likely to increase to 15% of the total loans by March, 2018. A majority of the NPAs are accounted by the Public Sector banks owing to large bureaucracy, lack of autonomy and compromised interests of the bank’s promoters. According to the Global Financial Stability Report by IMF, 36.9 % of India’s total debt is at risk, which is among the highest in the emerging economies while India’s banks have only 7.9 % loss absorbing buffer, which is among the lowest.
As per RBI reports,
- The aggregate balance sheets of Scheduled Commercial Banks (SCBs) showed a single-digit growth in 2015-16. Growth in profits showed a decline, primarily on account of a sharp increase in provisions made by public sector banks. Given the falling profit levels, both return on assets (RoA) and return on equity (RoE) showed a decrease.
- Non-Banking Financial Institutions registered a double-digit growth in income during 2015-16 despite a significant decline in non-interest income. Asset quality and capital adequacy marginally deteriorated in 2016.
- Credit to sensitive sectors viz. the capital market and real estate sector accounts for around 20 % of the total loans and advances by SCBs.
- The slowdown in credit growth along with poor valuations of bank stocks, banks are looking at newer ways of meeting their capital needs.
The genesis of the distress is irrational or unsubstantiated optimism. A number of bad loans were made in 2007-08 when economic growth was strong, deposit growth in the public sector banks was rapid, and a number of infrastructure projects such as power plants had been completed on time and within budget. It is at such times that banks make mistakes. They extrapolate past growth and performance to the future. So they were willing to accept higher leverage in projects, and less promoter equity. The bank debt fueled the rise in corporate leverage steadily from 2005 – 11. Bank lending to industrial sector in this period continued at an average elevated rate of over 20 %. There has been an increased propensity to defer provisions in an apparent attempt to post higher net profits attributable to short term tenure which the CEOs/ CMDs. The problems which are swept under the carpet for a quarter or two would need to be encountered thereafter, with the issue getting further complicated in the interim.
Categorically, Bad Asset Quality, low capital adequacy, unhedged foreign exposures and overlapping jurisdictions for public sector banks are the major reasons for the banking sector distress.
Policies by RBI to address NPAs:
- Financial Resolution and Deposit Insurance Bill, 2017 – It will lead to setting up of a Resolution Corporation which will protect the stability and resilience of the financial systems.
- The Scheme for Sustainable Structuring of Stressed Assets (S4A) for a deep financial restructuring of large accounts (> Rs 500cr) by allowing lender (bank) to acquire equity of the stressed project. It also envisages determination of the sustainable debt level for a stressed borrower.
- Asset Quality Review – Asset classification to compare the quality of loan assets against applicable Reserve Bank norms.
- Insolvency and Bankruptcy Code, 2016 for non-financial sectors.
- Large Exposure Framework (LEF) – lender’s total advances to a single company cannot be higher than 20 per cent of its capital base.
- Central Fraud Registry (CFR)-a web based searchable database of frauds containing data for the last 13 years & help in timely identification and mitigation of frauds and also serve as a potent tool for banks in taking informed business decisions.
- Non-performing assets ordinance – creation of a separate cell to identify issues pertaining to NPAs and have a clause providing definitive time-frame(60-90 days) for the resolution process.
- Liquidity Coverage Ratio (LCR-60%)-ratio of High Quality Liquid Assets (HQLA) to the Total Net Cash Outflows prescribed to address the short term liquidity risk of banks and the banks would be required to maintain a stock of HQLAs on an ongoing basis equal to the Total Net Cash Outflows.
- RBI has created a large loan database (CRILC) that covers all loans over Rs.5 cr. The data base being accessible to all the banks allows them to identify incipient sickness once early signals are notices.
- Mergers of small banks into bigger banks to cut operational costs and better management of financial services.
There is no overnight solution to this NPA issue, nor would the Band-Aid solutions as proposed by the experts really help rectify this crisis. These are only acknowledged in hindsight. So what really needs to be done is adopting robust and regulated banking operations with minimum involvement of bureaucracy.