Interpreting the Maladies.

On February 21,2017, newly brought in RBI Deputy Governor, Viral Acharya, focussed attention on the bad loan problem(conventionally referred to as Non Performing Assets,NPA issue). He reiterated the suggestion already made in the Economic Survey 2017–18 of establishing a Public Stressed Assets Rehabilitation Agency or PARA. The idea of having a Public Asset Management Company, as a centralised resolution of the debt problem has been borrowed from the experience of the East Asian Economic Crisis of the late 1990s. Albeit not spectacularly successful in its aims, PAMCs, in the past in other nations, have eased some fault lines.This idea is gaining more and more traction with the apparent failure of Asset Reconstruction Companies of taking up the stressed assets off bank balance sheets.(Less than 5% of cases have been resolved through ARCs)

Again in late April 2017, Mr Acharya stirred the hornet’s nest by merely suggesting re-privatisation of weak public sector banks,as a way to restore profitability in the banking system.

The issues of banking industry in India are multi farious.The present decade is undeniably a watershed moment for the sector as it wrestles with challenges of financial inclusion,anti-money laundering, evolving its capacity, both digital and otherwise, to serve the rapidly changing demands of a fast moving clientele,while at the same time dealing with the NPA issues, which linger around as untamed ghosts of the last decade’s countercyclical lending boom.

Since the phrase of NPA first entered the lexicon of Indian financial news segment in late 2010, very little has been understood about them, whilst a huge hue and cry made. The one issue NPAs definitely do not have, is that of public awareness.

Credit boom of mid 2000s as the Liberalisation schemes of 1991 started reaping the fruits, lead to start of large scale projects in construction and mining sector. Everyone was in an expansion mode and no one wanted to be left off the bus. Then the Global Financial Crisis of 2008 struck. The Government injected huge fiscal stimulus to keep the growth propped up. However the failure to withdraw the fiscal stimuli in time, in addition to slow global commodities’ demand lead to the alarmingly slow growth and the high inflation which not only made credit expensive, but also stressed.

The Government, Reserve Bank of India, the commercial banks, all have been trying different strategies to combat the menace. It commenced with the 5:25 approach of RBI in July 2014, where to remove the mismatch between project cash flows and repayment schedules, banks were allowed to extend the loan periods upto 20–25 years from the norm of 10–12 years. This was done as large, stressed projects in metals and infrastructure sector usually had delayed cash flows, far later than their loan schedules, which often lead to default. There was also a provision of extending project refinancing every 5 years. Terminal agencies like NABARD, SIDBI etc were also involved.

This was complemented by the herculean Asset Quality Review(AQR) exercise by RBI in 2015–16. The RBI usually conducts an inspection of loan portfolios of different banks as a part of its Annual Financial Inspection (AFI). Under AQR, the sample size was larger and almost all 200 large loan portfolios were examined. This was done to ensure that banks were correctly classifying the portfolios and not evergreening the stressed assets further.

If anything impacted the banking industry the most, it was the AQR. Toxic assets were out in the open, and there was no way to escape from the provisioning costs. Higher classification of stressed assets lead to higher provisioning, plunging bank ledgers into deep red. This was a cross industry phenomenon,both in private and public sector.

The target was to force the banks to Recognise the problem. The first R as per the Economic Survey 2015–16. This was to be followed by Recapitalization, Resolution and Reform of the Sector in phases latest by March 2017 so that bank books were healthy enough to implement Basel III Capital norms of 7% Tier 1 Capital equity to Risk Weighted Assets Ratio( in addition to the leverage ratio of 3% and revised liquidity ratio).

Two other schemes were launched- Strategic Debt Restructuring(SDR) issued in June 2015 and Scheme for Sustainable Structuring of Stressed Assets(S4A) in June 2016. While the former allowed Joint Lenders' Forum to take over NPAs,convert them to 51% stake and sell in 90 days, the latter divided the asset into sustainable and unsustainable, allowing restructuring(conversion of debt to equity) of the unsustainable ones, treating sustainable as standard assets.S4A was for the larger portfolios of more than 500 crores and had no unrealistic time limits for sale of the stressed portions.

The response to both has been lukewarm. Uncoordinated approach amongst lenders, low demand economy and unwillingness to take bigger percentage cuts in losses by lenders has prevented in sale and write offs of toxic assets from bank balance sheets.

March has come and gone with a mixed bag. The NPA problem is nowhere near to resolution.Some lenders like IDBI have seen the Gross NPA Ratio touching dangerous levels of close to 20% and losses running in hundreds of crores, others like SBI, Canara, HDFC have posted profits, ranging from modest to plush.

The problem seems to have receded from a macroscopic level to a microscopic one, centred around lenders with greater exposures to downturn industries and weaker operational capacities.Most private sector banks seem out of the woods,although conflicting data keeps appearing from time to time(the recent case of under reporting of NPAs by Yes Bank being one such case). Incidents like these dent the credibility of the industry at large.

However it would not be incorrect to say, that wherever negative Return on Assets are reported, post two quarters from now,(lets say), that would be an institution specific problem. Every organisation has a moment of crisis sometime or the other. It could be a technical one or an ethical one. Successfully tackling the problem head on is the make or break point.

Viral Acharya is probably right to some extent, when he appropriates the blame for stress in banking industry and by its linkages,to economy at large, on the legacy issues of weak public sector banks. When institutions sitting on 70% of deposits have credit growth of 5%, and one sixth toxic assets,it is implicit that status quo should not be continued with.Merger’s one way,(as the successful one of SBI has shown), re-privatisation is the possible other.It is also in keeping with the minimum government maxim, as nothing has been as detrimental for the Indian economy as its politicization.

With greater efficiencies, private sector has been pushing credit growth, especially in retail sector of the economy, but there is a limit to which they can share the burdens. Unless a proactive, efficient approach is taken up, weak public sector banks would rapidly cede market space and above all their significance. Mr Acharya believes that to be the natural progress with present parameters intact.

Indradhanush, the Recapitalization scheme, should not be made a recurring feature, as it would lead to greater unsustainable growth. The true sense of Reforms would be instilled only with large scale organizational overhauls and strict performance based incentives.