NPAs, Non Performing Actions & Systemic Risks to Public Monies

The crux is the systemic risk. There is the economic risk to depositors and growth and there is the political risk that will follow.

By Shankkar Aiyar | Published: 09th July 2017 04:00 AM |

Indians have in excess of 105 trillion rupees, or Rs 106.50 lakh crore to be precise, parked in the banks. Of this, 7 of 10 rupees is with the public sector banks (PSBs). Earlier this month, the Reserve Bank of India (RBI) released the Financial Stability Report (FSR) and spelt out some stark facts.

Between April 2016 and March 2017, while deposits grew by nine per cent, growth in lending was 0.8 per cent — that is, just a miniscule portion of additional deposits could be deployed by the banks to earn from. For the second year in succession, PSBs ‘recorded negative returns on their assets’.

Unsurprisingly, the value of the shares of just five PSBs is twice the market capitalisation of 21 listed PSBs — indeed HDFC Bank has a market capitalisation that is larger than all the PSU banks.

Worse, bad loans or gross non-performing assets have gone up from 9.83 per cent as on March 2016 to 12.23 per cent, and the projections of the FSR show these could touch nearly 14 per cent by March 2018.

The FSR cautions: “A severe credit shock is likely to impact capital adequacy and profitability of a significant number of banks”, and that the worst-affected would be PSBs.

Much could change for the better if the economy picks up steam, triggering the virtuous cycle of consumption, pushing demand, triggering job creation leading to investment and growth. Is there hope on the horizon — for a pick-up in investments and credit growth? The FSR survey finds that perceptions of risk — on global macro-economic, financial market, institutional and general factors — impacting economic growth are perceived to be higher, thanks mainly to global uncertainties.

While the jury is out, for now, nearly Rs 6 lakh crore of public monies is at risk. It bears mention here that deposit insurance covers barely Rs 1 lakh of deposits — and it is estimated that nearly half of all the deposits are between Rs 1 lakh and Rs 15 lakh. The good news is that PSBs are owned by the Government of India and the embedded belief is that the government will not allow them to fail. The long history of failures of many private and cooperative banks shows that every bust has been followed by rescue and rehabilitation orchestrated by the regulator and the government.

The bad news is that the pile-up of bad loans is rising, and could get worse. According to the FSR, stress tests reveal: “As many as 10 banks” will not be able to maintain the required capital-to-risk ratio “if top five group borrowers default”.

There is no denying the spectrum of actions, ranging from concept of Indradhanush to the creation of the Bank Board Bureau. Indeed, many acronym soups of schemes have been brewed, mostly flailing and failing — there is the stack of NPAs and then there is a new stack of non-performing actions.

Unsurprisingly, the government toughened its stance and deployed the Insolvency and Bankruptcy Code (brought in via an ordinance). A step former RBI governor Y V Reddy has dubbed as “unconventional”, for the owner to ask the regulator to ensure recovery. Notwithstanding the new normal, the RBI panel acted promptly, listing 12 accounts with roughly Rs 2 lakh crore in outstanding loans for action — which essentially means taking them to the National Company Law Tribunal for due process.

The action has been challenged in the courts by the borrowers — on semantic and substantive issues, from the wording of the press release issued by the RBI, and on the due diligence behind the selection of the 12 accounts, including the cut-off date of March 2016. It is clear is that the road to redemption for banks is a long and arduous one.

The bigger question that demands attention is the rescue and rehabilitation of PSBs — trapped in the Gordian knots of ownership, management and systemic ailments.

Regardless of what actions are being contemplated on the recovery of loans, there is no escaping the need to recapitalise banks. There are quite a few proposals floating around.

The simplest is government providing additional capital to enable banks to lend. For this the government would need to raise funds and it could do it in the bond market — it would need to tweak tax incentives to create the window, of say, Rs 1 lakh or expand the current exemption for investments to allow people to invest in long tenure bonds. The government has shied away from this for a variety of reasons citing market appetite, fiscal constraint and the argument of making banks pay their way through.

The alternative floated in the echo-chambers, inspired by 1970s politics, is to corral a percentage of deposits in all accounts, a la the compulsory deposit scheme, convert it into long tenure bonds to recapitalise banks. It will be seen as extractive and will face political criticism and resistance. Also on the table are suggestions for mergers with bigger banks, with private entities and outright sale, as mooted for IDBI Bank. At current low equity valuations, there is a moral hazard here — these banks are owned by people, and sale/merger at current valuation would represent nationalisation of losses and privatisation of profits at a later date.

The sane and safe option before the government is to issue fresh equity for retail investors and raise capital — price it at a discount, enable the people to bet on the Indian economy and let the gains accrue to the widest possible group.

The issue of fresh equity will effectively bring down its holding in these banks and shore up capital adequacy. It should then create an India Reconstruction Bank — a special purpose vehicle to park “bad assets” as was done for UTI under M Damodaran during Atal Bihari Vajpayee regime.

It could even issue equity or bonds to raise resources to buy off the bad loans and enable payback. Finally, it should transfer all its holdings in all the banks into a sovereign entity, as suggested by this column and also by the Nayak Committee, to professionalise management. It is time for the government to get out of managing businesses and transit to the role of a strategic investor.

The crux is the systemic risk that status quo entails. There is the economic risk — to the depositor and to the economy. The aspiration of eight per cent GDP growth calls for intervention to promote credit growth and investment. There is also the political risk — the mass of people, the number of banks, and the threat to job creation.

Shankkar Aiyar is the author of Aadhaar: A Biometric History of India’s 12 Digit Revolution and Accidental India:

You can email him at or follow him on Twitter. His previous columns can be found here. This column was first published here​.

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