What is the extent and effect of the NPA problem in India?
Banks give loans and advances to borrowers. Based on the performance of the loan, it may be categorized as: (i) a standard asset (a loan where the borrower is making regular repayments), or (ii) a non-performing asset. NPAs are loans and advances where the borrower has stopped making interest or principal repayments for over 90 days.
Escalating NPAs require a bank to make higher provisions for losses in their books. The banks set aside more funds to pay for anticipated future losses; and this, along with several structural issues, leads to low profitability. The profitability of a bank is measured by its Return on Assets (RoA), which is the ratio of the bank’s net profits to its net assets. Banks have witnessed a decline in their profitability in the last few years, making them vulnerable to adverse economic shocks and consequently putting consumer deposits at risk.
What led to the rise in NPAs
A lot of the loans currently classified as NPAs originated in the mid-2000s, at a time when the economy was booming and the business outlook was very positive. Large corporations were granted loans for projects based on extrapolation of their recent growth and performance. With loans being available more easily than before, corporations grew highly leveraged, implying that most financing was through 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. This contributed to what is now known as India’s Twin Balance Sheet problem, where both the banking sector (that gives loans) and the corporate sector (that takes and has to repay these loans) have come under financial stress.
When the project for which the loan was taken started underperforming, borrowers lost their capability of paying back the bank. The banks at this time took to the practice of ‘evergreening’, where fresh loans were given to some promoters to enable them to pay off their interest. This effectively pushed the recognition of these loans as non-performing to a later date but did not address the root causes of their unprofitability.
Further, recently there have also been frauds of high magnitude that have contributed to rising NPAs. Although the size of frauds relative to the total volume of NPAs is relatively small, these frauds have been increasing, and there have been no instances of high-profile fraudsters being penalized.
What is being done to address the problem of growing NPAs?
The measures taken to resolve and prevent NPAs can broadly be classified into two kinds – first, regulatory means of resolving NPAs per various laws (like the Insolvency and Bankruptcy Code), and second, remedial measures for banks prescribed and regulated by the RBI for internal restructuring of stressed assets.
The Insolvency and Bankruptcy Code (IBC) was enacted in May 2016 to provide a time-bound 180-day recovery process for insolvent accounts (where the borrowers are unable to pay their dues). Under the IBC, the creditors of these insolvent accounts, presided over by an insolvency professional, decide whether to restructure the loan or to sell the defaulter’s assets to recover the outstanding amount. If a timely decision is not arrived at, the defaulter’s assets are liquidated. Proceedings under the IBC are adjudicated by the Debt Recovery Tribunal for personal insolvencies, and the National Company Law Tribunal (NCLT) for corporate insolvencies. 701 cases have been registered and 176 cases have been resolved as of March 2018 under the IBC.
Over the years, the RBI has issued various guidelines aimed at the resolution of stressed assets of banks. These included the introduction of certain schemes such as (i) Strategic Debt Restructuring (which allowed banks to change the management of the defaulting company), and (ii) Joint Lenders’ Forum (where lenders evolved a resolution plan and voted on its implementation). In line with the enactment of the IBC, the RBI, through a circular in February 2018, substituted all the specific pre-existing guidelines with a simplified, generic, time-bound framework for the resolution of stressed assets.
In the revised framework which replaced the earlier schemes, the RBI put in place a strict deadline of 180 days during which a resolution plan must be implemented, failing which stressed assets must be referred to the NCLT under IBC within 15 days. The framework also introduced a provision for monitoring of one-day defaults, where incipient stress is identified and flagged immediately when repayments are overdue by a day.
Tackling non-performing assets will be a major challenge for the banking sector in the new year as many companies, especially in the MSME sector, may not be able to withstand the heat of the coronavirus pandemic which led to a historic contraction of the economy in the first half of the current fiscal.
Besides, muted private investment impacting the corporate loan growth will be another challenge that banks will have to face in the coming months. Despite ample liquidity in the system, demand from the corporate sector is very low and bankers hope that faster than anticipated recovery could bring in the animal spirit as far as India Inc is concerned.
Although the Indian economy witnessed a sharp recovery from a 23.9 percent contraction in the first quarter to 7.5 percent contraction in the second quarter, it is yet to lift the sentiment of India Inc. For the past few years, private investment has been low while public spending has been doing the heavy lifting for the economy.
Effective April 1, the United Bank of India and Oriental Bank of Commerce were merged with Punjab National Bank, making it the second-largest Public Sector Bank (PSB).
Similarly, Andhra Bank and Corporation Bank were merged with Mumbai-based Union Bank of India. Syndicate Bank was merged with Canara Bank while Allahabad Bank was amalgamated with Chennai-based Indian Bank.
“The merger has nearly stabilized… It happened very seamlessly despite the lockdown and the early positive signs of the amalgamation are now also visible,” Financial Services Secretary Debasish Panda told PTI.
“They now have a larger capital base and their capacity to lend has increased, and then you have complementary products of the different banks that merged into the lead banks,” he said.
To provide relief to millions of borrowers who faced disruption in their income due to the lockdown, banks under the guidance of RBI extended the moratorium for six months till August.
Over 40 percent of the system credit and 75 percent of the borrowers benefited from the decision and it also resulted in an additional burden of around ₹7,500 crore for the government.
For the large corporates, banks, under the direction of RBI, have implemented a one-time restructuring of loans within strict parameters. Companies under stress have been given time till December to avail the scheme.
Coming to the issue of credit offtake, the core job of banks, it remained muted during most part of the year. However, disbursal of agriculture and retail loans gather substantial momentum from September onwards.
“We have seen that there is a steady uptick in the credit growth. The retail loan, home loan, and agriculture loan have picked up, and MSME, again, with the intervention of the government through the ECGLS and other similar schemes also has picked up,” Panda said.
There is some subdued growth in the corporate segment, he said, adding that banks and the government are working together to revive demand for corporate loans and recently, the ECGLS was extended to more distressed sectors.
Under the Emergency Credit Line Guarantee Scheme (ECLGS), banks have sanctioned loans worth ₹2.05 lakh crore to 81 lakh MSMEs that were impacted by disruptions caused due to the pandemic.
The K V Kamath Committee, which helped the RBI with designing a one-time restructuring scheme, also noted that corporate sector debt worth Rs 15.52 lakh crore has come under stress after Covid-19 hit India, while another Rs 22.20 lakh crore was already under stress before the pandemic. This effectively means Rs 37.72 lakh crore (72% of the banking sector debt to industry) remains under stress. This is almost 37% of the total non-food bank credit.
the jury is still out on the trajectory of bad loans. One school of thought is that NPAs are bound to increase largely because of MSMEs but bankers and policymakers are not that pessimistic.
Gross NPAs of all banks may jump to 12.5 percent by the end of this fiscal under the baseline scenario from 8.5 percent in March 2020, according to the Financial Stability Report (FSR) released by RBI in July.
However, due to faster than anticipated recovery, there is an uptick in the banking sector as well and most of the banks, including private-sector lenders, have posted good profits during the July-September quarter. This was mainly on account of treasury income and reduction in NPAs.
“We don’t anticipate a big shock to hit public sector banks next year given the high provision coverage ratio, steady decline in non-performing assets (NPA), and one-time restructuring corporate, among other things,” Panda said.
About the financial health of banks, Panda said that 11 out of the 12 public sector banks posted profit in the last quarter. Even gross NPAs have gone down substantially and the provision coverage ratio has increased, he added.
To cushion against future shock, the secretary said that public sector banks have raised ₹40,000 crore in the form of equity, and bonds and another ₹25,000 crore would be raised in the next three months.
Besides, the government has allocated ₹20,000 crore for capital infusion into PSBs in the current fiscal. Of this, the finance ministry has granted ₹5,500 crore to Punjab & Sind Bank to meet regulatory requirements.
THE OTHER SIDE OF THE COIN.
For banks in India, tackling the ballooning non-performing assets (NPA) will be the biggest challenge in 2021 as loan defaults have to spiked sharply in Covid-hit 2020. Many small and medium-scale companies are still struggling to repay dues owed to banks.
A large number of individuals are also struggling to repay their loans after losing income or employment due to the historic economic crisis triggered by the coronavirus pandemic and the initial lockdown.
While banks have been reporting a decline in NPAs in the last few months, there is a high possibility that forbearance on asset classification is masking bad loans that are constantly on the rise, according to S&P Global Ratings.
The global rating agency also mentioned in its report that the performance of Indian banks exceeded expectations in the second quarter, but added that much of it was due to the six-month loan moratorium and the Supreme Court’s decision barring banks from classifying loans as NPAs.
It said banks could have seen their NPAs rise by 10-60 basis points if it had not been for the top court’s ruling. The top court had allowed banks to maintain loan accounts as standard even as borrowers defaulted.
Thousands of crores worth of loans have gone sour due to non-payment by borrowers and the amount of NPAs is likely to increase further. And the global rating agency is not too optimistic about the loan restructuring plan.
“We estimate that more than half of our estimated restructured book may eventually slip into NPLs, leading to elevated NPL and credit cost levels in subsequent fiscal years,” S&P Global Ratings said in its report.
While there are other problems like low corporate loan growth, the NPA problem seems to be the biggest “hidden” issue that may erupt by 2022 when relaxations like loan restructuring come to an end. But at the moment, the government and banks in the country are confident that there are enough provisions to absorb any forthcoming shock.
What Is a Bad Bank?
A bad bank conveys the impression that it will function as a bank but has bad assets to start with. Technically, a bad bank is an asset reconstruction company (ARC) or an asset management company that takes over the bad loans of commercial banks, manages them and finally recovers the money over a period of time. The bad bank is not involved in lending and taking deposits, but helps commercial banks clean up their balance sheets and resolve bad loans. The takeover of bad loans is normally below the book value of the loan and the bad bank tries to recover as much as possible subsequently.
Now, with the pandemic hitting the banking sector, the RBI fears a spike in bad loans in the wake of a six-month moratorium it has announced to tackle the economic slowdown.
Will a bad bank solve the problem of NPAs?
Despite a series of measures by the RBI for better recognition and provisioning against NPAs, as well as massive doses of capitalization of public sector banks by the government, the problem of NPAs continues in the banking sector, especially among the weaker banks. As the Covid-related stress pans out in the coming months, proponents of the concept feel that professionally-run bad banks, funded by private lenders and supported by the government, can be an effective mechanism to deal with NPAs. The bad bank concept is in some ways similar to an ARC but is funded by the government initially, with banks and other investors co-investing in due course. The presence of the government is seen as a means to speed up the clean-up process. Many other countries had set up institutional mechanisms such as the Troubled Asset Relief Programme (TARP) in the US to deal with a problem of stress in the financial system.
In May 2020, the Indian Banks’ Association (IBA), a body representing major Indian banks submitted a proposal to the RBI and Government to set up a national Bad Bank. According to the proposal, the bad bank would initially start with a book of approximately Rs.75000 Crores worth of bad loans.
The IBA has proposed a corporate structure that would contain an asset reconstruction company (ARC), to be owned by the Government along with an alternate investment
fund (AIC) and an asset management company (AMC) that would have both – public and private participation. The banks would cumulatively invest Rs.100 Crores in the AMC and the ARC would be capitalized by the Government to the tune of Rs.10,000 Crores.
Many industry trade bodies, banks, and economists are in favor of creating a bad bank. Proponents argue that it is important to clean the balance sheet of the banks. Stress in the banking sector has prevented credit growth in the past, and it will also hinder the efforts to recover the economy post-Covid.
- Mobilizing Capital: Finding buyers for bad assets in a pandemic hit economy will be a challenge, especially when governments are facing the issue of containing the fiscal deficit.
- Not Addressing the Underlying Issue: Without governance reforms, the Public sector banks (accounted for 86%, of the total NPAs) may go on doing business the way they have been doing in the past and may end up piling-up of bad debts again.
○ Also, the bad bank idea is like shifting loans from one
government pocket (the public sector banks) to another (the
- Provisioning Issue Tackled Through Recapitalization: Union Government, in the last few years, has infused nearly Rs 2.6 lakh crore in banks through recapitalization.
○ Those who oppose the concept of bad banks hold that the
government has on its part recapitalized the banks to
compensate for the write-offs and hence, there is no need for a
- Market-related Issues: The price at which bad assets are transferred from commercial banks to the bad bank will not be market-determined and price discovery will not happen.
- Moral Hazard: Former RBI Governor Raghuram Rajan had said that a bad bank may create a moral hazard and enable banks to continue reckless lending practices, without any commitment to reduce NPAs.
- The case for setting up a bad bank is not so obvious; many are not in support of this idea. It is argued that creating a bad bank is just shifting the problem from one place to another. It will not help in alleviating the problem of NPA’s in the banking sector.
The bad bank would only lead to losses being shared among investors and the public and it is highly likely that it will just become a warehouse for bad loans without any recovery taking place. Instead, we must focus on tackling the underlying structural problems in the banking system and make reforms to improve the public sector banks.
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