Melwin Joy
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Bank NPAs: A 5Ws-2Hs Analysis

What is an NPA?

Conceptually speaking a credit facility becomes an NPA when it ceases to generate income for bank. NPAs can be sub-standard if pending for 12 months, doubtful if above 12 months, and lost NPA if it is long-drawn with little hope of recovery. A loss of asset is one where loss has been identified by the Bank, an Internal or External auditor, or during Reserve Bank of India Inspection.

As per the Reserve Bank rules, out of every Rs.100 deposited in a bank, Rs.4 is parked with the RBI, and Rs.19.5 in assets like bonds or gold. Almost a quarter of the money in the system can be retrieved in case of a contingency while the bank is free to lend the remaining Rs.76.5 to corporate or retail borrowers. The interest gleaned on such loans is used to compensate the bank’s customers as interest payment, and the remainder is the bank’s profit. NPAs arise when banks lend to clients who default on their repayment, thereby leading the bank to become sick gradually. The Financial Stability Report, 2017, released by the RBI, states that India’s gross NPAs stands at 9.6%, though Care Ratings finds NPAs at 11% of total lending by public sector banks (PSBs). India has the second highest ratio of NPAs among the major economies of the world. Only Italy, with 16.4% NPAs has more stressed assets. China, whose economic growth is largely fuelled by borrowings, has only 1.7% NPAs, according to the International Monetary Fund (IMF). According to the former RBI Governor Raghuram Rajan, broad estimates show that Indian banks are currently burdened with bad loans that amount to more than Rs 9 lakh crore, public and private banks together.

Why do NPAs happen?

NPAs can rise due to several reasons, like when the borrowers diversify funds to unrelated business or engage in frauds. There can be lapses by the bank during due diligence. Often there are business losses due to changes in business/regulatory environment. There are evidences of a lack of morale among the borrowers, particularly after government schemes which had written off earlier loans.

Then, there are cases of global, regional or national financial crisis which results in erosion of margins and profits of companies, therefore, stressing their balance sheet which finally results into non-servicing of interest and loan payments (for example, the 2008 global financial crisis). The general slowdown of entire economy is another reason. For example after 2011 there was a period of slowdown in the Indian economy which resulted in the faster growth of NPAs. There can also be a slowdown in a specific industrial segment, therefore, companies in that area bear the heat and some may become NPAs. It has happened in the construction industry.

Unplanned expansion of corporate houses during boom period and loan taken at low rates later being serviced at high rates, therefore, can be resulting into NPAs. Also, NPAs can be due to mal-administration by the corporate houses, for example, wilful defaulters. Misgovernance and policy paralysis in borrowing houses hamper the timeline and speed of projects, therefore, loans become NPAs. For example Infrastructure Sector had been affected by bad and lack of decisions both at government and corporate levels. Severe competition exists in any particular market segment. For example Telecom sector in India. Delay in land acquisition due to social, political, cultural and environmental reasons can also lead to NPAs. There are cases of bad lending practices in case of Kingfisher and Nirav Modi or Geetanjali Jewellery cases, which are non-transparent ways of giving loans.

NPAs can also be due to natural reasons such as floods, droughts, disease outbreak, earthquakes, tsunami etc. Further, there are cases of cheap import due to dumping leads to business loss of domestic companies. For example, steel sector in India.

Political decision-making, formal and backdoor, are a major reason of corporate NPAs.

The current Indian government had no hesitation to write off Rs 2.41 lakh crores in last 3 years, and gross NPA stands at Rs.9 lakh crores today, which was around Rs.3 lakh crores in 2014. Sanjay Das, Secretary, All India Bank Officers Confederation (AIBOC), West Bengal, notes that for the last four years, public sector banks have been earning operating gross annual profits ranging from Rs.1.3 lakh crores to Rs.1.6 lakh crores, but net profit is wiped out due to the bad loans, given not at the whims of employees and the faulty provisioning norms, but through political decisions.

Whose responsibility?

First, there is a nexus between manipulative borrowers and public sector bank officials, often with political blessings, who rip off public sector banks, best witnessed recently in the Punjab National Bank (PNB) fraud at the Fort branch in Mumbai where diamond merchant Nirav Modi allegedly colluded with branch officials for several years to hoodwink the bank.

Second, there are farm loans, whose waivers irk copybook economists but are mercifully not being discussed much this year, partly because general elections are close by and mostly because farmers pale in comparison to the fat cat borrowers.

Former RBI Governor Rajan’s recent note to the parliamentary committee on bad loans makes it abundantly clear how many corporate borrowers have gamed the system, both in obtaining loans as well as in the resolution process.

It is important to note that the Corporate Industry Loans (73% of all NPAs) are sanctioned by government appointed Board Level Executives to Industry like Bhushan Steel, Lanco Infra, Essar Steel, Amtek, Monnet Ispat, Reliance, Adani groups, and to people like Nirav Modi, Vijay Mallya, et al. Agriculture NPA (9%) is mostly due to Farm Loan Waiver policies by newly elected governments just before or after elections, and so such borrowers misuse loans. Services NPA (13%) is mostly like MUDRA loan, where the current central government bars Banks to take collateral, and hence Banks cannot recover and the borrowers happily default. Retail NPA, accounting for less than 4% of all NPAs, is the only NPA where a common branch level Banker makes a sanction in form of Housing, Car, Personal loan et al.

When and why?

The RBI’s Financial Stability Report names the basic metals and cement industries as the most indebted, with 45.8% and 34.6% stressed assets respectively. Despite the recent GDP numbers which point to lukewarm growth, the metals industry continues to be hamstrung by slow demand and cheaper imports. The construction, infrastructure and automobile industries also account for a sizeable chunk of banks’ NPAs.

Data collected by the Ministry of Statistics and Programme Implementation (MOSPI) and compiled by the World Bank reveals that economic growth tapers off with a spike in the bad loan ratio. While economic output has been laggard over the past few quarters owing to disruptive policies such as demonetisation and the implementation of the goods and services tax (GST), the lacklustre performance of India Inc. has pulled down banks with greater defaults from corporate clients. The gross NPA ratio has spiked from 5.9% in 2015 to 9.6% in 2017 while economic growth has slumped in the corresponding period.

NPAs make the banks – the lenders – suffer lowering of profit margins. Stress in banking sector causes less money available to fund other projects, therefore, negative impact on the larger national economy. Higher interest rates are imposed by the banks to maintain the profit margin. There can be redirecting funds from the good projects to the bad ones. As investments got stuck, it may result in unemployment. In the case of public sector banks, the bad health of banks means a bad return for a shareholder which means that government of India gets less money as a dividend. Therefore, it may impact easy deployment of money for social and infrastructure development and results in social and political cost. Investors do not get rightful returns. Both the banks and the corporate sector have stressed balance sheet and causes halting of the investment-led development process. NPAs related cases add more pressure to already pending cases with the judiciary.

How we tackle it?

Rajan said that the RBI could have started the asset quality review (AQR) process earlier than it did and that it could have been “more decisive in enforcing penalties on non-compliant banks”. The process of stricter monitoring has started recently.

The Mission Indradhanush framework, 2015, created for transforming the PSBs, represents the most comprehensive reform effort undertaken since banking nationalization in the year 1970 to revamp the Public Sector Banks (PSBs) and improve their overall performance by ABCDEFG.

  • A-Appointments: Based upon global best practices and as per the guidelines in the companies act, separate post of Chairman and Managing Director and the CEO will get the designation of MD & CEO and there would be another person who would be appointed as non-Executive Chairman of PSBs.
  • B-Bank Board Bureau: The BBB will be a body of eminent professionals and officials for appointment of Whole-time Directors as well as non-Executive Chairman of PSBs.
  • C-Capitalization: As per finance ministry, the capital requirement of extra capital for the next four years up to FY 2019 is likely to be about Rs.1,80,000 crore out of which 70000 crores will be provided by the GOI and the rest PSBs will have to raise from the market.
  • D-Destressing: De-stressing PSBs and strengthening risk control measures and NPAs disclosure.
  • E-Employment: Banks are encouraged to take independent decisions in recruitments keeping in mind the commercial the organizational interests.
  • F-Framework of Accountability: New KPI (key performance indicators) which would be linked with performance and also the consideration of ESOPs for top management of PSBs.
  • G-Governance Reforms: For Example, Gyan Sangam, a conclave of PSBs and financial institutions, and Bank Board Bureau for transparent and meritorious appointments in PSBs.

Insolvency and Bankruptcy code Act-2016: It has been formulated to tackle the Chakravyuh Challenge of the exit problem in India. The aim of this law is to promote entrepreneurship, availability of credit, and balance the interests of all stakeholders by consolidating and amending the laws relating to reorganization and insolvency resolution of corporate persons, partnership firms and individuals in a time bound manner and for maximization of value of assets of such persons and matters connected therewith or incidental thereto.

Bad Banks – 2017: Economic Survey 16-17, also talks about the formation of a bad bank which will take all the stressed loans and it will tackle it according to flexible rules and mechanism. It will ease the balance sheet of PSBs giving them the space to fund new projects and continue the funding of development projects. It has not been put to practice yet.

Innovative tackling

The need of the hour to tackle NPAs is some urgent remedial measures. This should include technology and data analytics to identify the early warning signals, a detailed mechanism to identify the hidden NPAs, development of internal skills for credit assessment within the banking system, and forensic audits to understand the intent of the borrower.

Raghuram Rajan gave us the term ‘non-cooperative defaulter’ to describe the corporate bigwigs who can’t or won’t pay back the loans they took. Arvind Subramanian speaks now of ‘stigmatized capitalism’ that stops the government from reformist solutions to the NPA problem. All diagnosis, no cure. Unless you find some merit in Subramanian’s preference for a ‘judicial solution’ to the pile of unpaid loans in listed banks.

Today, without a framework for bankruptcy and orderly resolution for financial firms, India faces the risk that if a large private sector bank goes bankrupt; there is no legal way of dealing with it other than to force a public sector bank or insurance company like the Life Insurance Company to buy it out. To serve the growing needs of the economy for debt, equity, payment systems, and innovations in financial products and services it is required that regulatory reform is undertaken with much greater speed.

A corporate bond market is the ideal solution for freeing banks and businesses from this eternal cycle of bank loans and NPAs. The idea remains still-born despite numerous committees recommending it. The fortunes of the market are currently hostage to an inter-regulator turf battle. There are no easy solutions for NPAs; at least not till April 2019.

Author – Prof. Ujjwal K. Chowdhury

The author is a media academic and columnist, currently Dean of Media, Pearl Academy, Delhi and Mumbai, and earlier the Dean of Media of Symbiosis & Amity Universities.

Melwin Joy
AUTHOR

Melwin Joy

All stories by: Melwin Joy