Bleeding banks need more than a bandage

The NPAs have risen to Rs 10 lakh crore and farm loans make a very small portion of it. Will the recent RBI actions help?

The Reserve Bank of India (RBI) has decided to act against 12 big corporates responsible for 25 percent of the Rs 10 lakh-crore non-performing assets (NPAs) in Indian banks. However, despite the Supreme Court order in 2015, the RBI has refused to make the list of loan defaulters public.

The banking industry is in shambles thanks to high level of NPAs, especially in public banks. According to a report by the Public Finance Public Accountability Collective (PFPAC), the NPAs rose from a mere Rs 50,517 crore in 2007 to Rs 5,41,763 crore in 2016. In a period of six months, between September 2015 and March 2016, the amount of NPAs shot up by a staggering 46 percent. That they now stand at Rs 10 lakh crore underscores the economic slowdown and failure of remedial measures.

A CARE Ratings report found that NPAs of 13 public sector banks jumped 57 percent from Rs 1.67 lakh crore in December 2015 to Rs 2.33 lakh crore in March 2016. These banks added Rs 50,000 crore more in NPAs in the next four quarters till March 2017.

NPAs are those loans given by a bank that don’t perform i.e., don’t bring any return. Once the borrower fails to make interest or principle payments for 90 days then the loan is considered to be an NPA.

Public sector banks at risk

The asset quality of public sector banks has deteriorated in comparison to private sector banks as big corporate loans come from them. Sectors such as infrastructure, steel, textiles, aviation, and mining have contributed to a big rise in the NPAs.

The economic slowdown of 2008-09 led to projects being stalled and corporate balance sheets being stretched. However, when the RBI Governor blames external factors and the slowdown of economic growth for a rise in NPAs of public sector banks, it does not sound convincing. Banks are expected to take these factors into account when they are extending huge loans to infrastructure sector.

The share of public sector banks in total NPAs increased from 65.54 percent in 2008-09 to 86.24 percent in 2014-15, while the private banks brought down their share of NPAs from 24.05 percent to 10.43 percent. The bias of the public sector banks to lend heavily, especially in infrastructure sector, unlike the private banks, shows a lack of proper risk assessment on their part, and possible political interference to favour corporates.

Rise in NPAs affects the whole economy. Due to NPAs, banks follow low interest policy on deposits and high interest policy on loans provided. This puts pressure on recycling of funds and creates problem in getting new buyers.

Indian Overseas Bank performed the worst with the highest ratio of NPAs (20.26 percent) against total debt, followed by UCO Bank (18.66 percent) and Bank of India (16.01 percent). But when compared in absolute terms, State Bank of India has the highest value of Gross NPA at Rs 93,000 crore followed by Punjab National Bank (Rs 55,000 crore) and Bank of India (Rs 44,000 crore).

The RBI has put IDBI, Indian Overseas Bank, UCO Bank, Dena Bank and Central Bank of India under the Prompt Corrective Action, which is equivalent to noose-tightening on fresh loan disbursal and dividend distribution.

Farm versus corporate loans

With the Uttar Pradesh government announcing farm loan waive amounting to Rs 36,359 crore, several other states, especially Madhya Pradesh and Maharashtra, are under intense pressure to follow suit.

Both agricultural and corporate loans are treated differently by the banks and governments even when both these are state subjects. According to a study report, industry accounts for two-thirds and services nearly 20 percent to the total NPAs. Agriculture and retail lending account for nearly 10 percent and five percent, respectively, of overall NPAs.

Traditionally, NPA levels of the priority-sector lending, which includes farm loans, face a higher NPA-to-loan ratio than the non-priority sector. However, as per data from 2011 to 2016, the agriculture loan NPAs stood between four and six percent while the industry NPAs have consistently increased sharply from nearly three percent in 2011 to 12 percent in 2016.

Treating corporate defaulters with velvet gloves, thus, is not justified.

Sham of Debt Restructuring

Corporate Debt Restructuring (CDR) is re-evaluation of a company's loan by decreasing the interest rate or/and extending the time period by which company should pay back. Also, banks may forego some of the debt in exchange for an equity in the company.

The problem is that CDR should have been used as a last resort to deal with a crisis but now has become an easy instrument used by the banks and companies to cover the problem of poor financial health, along with hiding the true scale of the problem of NPAs.

The PFPAC report says that number of CDR cases rose steadily from 2009 onwards and saw a drastic drop only in 2014-15 after an RBI notification that the banks can form a joint lenders forum and take corrective measures that may or may not be referred to the CDR cell. This effectively means that debt restructuring can be done outside of the CDR mechanism.

The 5/25 debt restructuring scheme allows for refinancing of the loan every five years for 25 years based on progress made by the company. However, the RBI governor said that the banks are exposing themselves to undue risk by pushing a large part of debt obligations into later part of project life.

The RBI’s strategic debt restructuring scheme, launched in 2015, also has an inherent problem as it allows banks to convert the loan amount and interest into equity share of the company. The condition is that the banks should divest 26 percent of this equity share within 18 months. Experts argue that this would be masking the NPAs and delaying the inevitable.

Sanjay Bhattacharya, former Managing Director and Chief Credit and Risk Officer, SBI, said, “The bank itself doesn’t have a wherewithal to run the company...looking for alternative management is a time-consuming process while the company continues to flounder...banks will also find it difficult to find buyers.”

A report by Religare Institutional Research says instead of helping, the scheme exacerbates the risk by deferring an estimated Rs 1.5 million of NPA from 2016-17 to later years.

Problem with virtual assets as collateral

Collateral is a property or some asset offered by a borrower to the lender as a security for the repayment of the loan. The higher the amount of the loan, the higher the value of collateral has to be offered to the banks.

The problem of NPAs gets worse when the banks compromise with this safety and give loans to companies against ‘virtual assets’, like shares of promoters, shares of subsidiary companies, brand names of the companies etc., which may turn out to be of insufficient value when the company undergoes heavy losses and the share prices crash.

In the case of Kingfisher Airlines, where a loan of Rs 7,723 crore was given by a group of banks, the brand alone was valued at Rs 4,111 crore. The total collateral amount was Rs 5,329 crore. Banks are still facing hard time in recovering their money, along with dragging Vijay Mallya to courts to make him pay back the loans.

In many cases, group or subsidiary companies become guarantors. As RBI noted in its Financial Stability Report 2014, a majority of companies in India are family owned/controlled and substantial levels of promoter shareholding are concentrated within the family hold. By pledging shares, the promoters have no personal liability other than the pledged shares.

What the government did

Taking into account the steep rise of NPAs in the Indian Banking system, the RBI came out with a framework in January 2014. Between 2008-09 and 2014-15 the government did a total capital infusion of 85 roughly Rs 70,000 crore in the PSBs. Further, the demonetisation exercise in November last year also led to deposit of Rs 12.44 lakh crore in the banks.

The need for capital infusion is seen by many as a ‘bailout’ measure for the banks to offset the detrimental effects of NPAs to a large extent caused by mismanagement within the PSBs.

Debt Recovery Tribunal (DRTs)- The tribunals evolved as a mechanism to provide a legal alternative for the banks to recover their loans in a speedy manner instead of running to civil courts, which were constantly overburdened thus causing years of delay.

n 2014-15, 1,71,113 cases amounting to Rs 3,78,900 crore were referred to DRTs, through which banks were able to recover Rs 53,100 crore. In the current scheme of things there is no mechanism in place to ensure that the tribunal disposes of the case in a timely manner, which is why the percentage of recovery over referred cases has declined over the years.

SARFAESI Act, 2002 - The Securitisation And Reconstruction of Financial Assets and Enforcement of Security Interest (SARFAESI) Act, 2002 was introduced to allow banks take possession of securities of defaulters and sell them. In 2014-15, 12,41,086 cases involving Rs 4,70,500 crore were referred under SARFAESI Act, through which banks were able to recover Rs 1,15,200 crore. Here, too, the ratio of recovered amount to referred amount has been falling steadily over the years.

Banks today have an arduous task of both effectively managing the NPAs as well as keeping their profitability intact. In order to achieve this, the banks need a well-established credit monitoring system. Proper evaluation of a credit proposal, a centralised model for sanctioning and recovery of loans, specialised staff, timely watch on performance of the borrowers and transparency in dealings need to be ensured to resolve this gigantic problem.

Disclaimer: This article, authored by Shachi Singh was first published on GOI Monitor.