RESOLVING THE NPA CRISIS IN INDIAN BANKS

The Economic Survey of 2015-16 acknowledges that one of the critical challenges confronting the Indian economy is ‘the twin balance sheet’ problem. The balance sheets of both public sector banks (PSBs) and some corporate houses are in terrible shape and it has been seen as a major obstacle to investment and reviving growth.

The problems faced by the Public Sector Banks are linked directly to that of the corporate sector. During the boom years, some companies borrowed a lot of money from banks to invest in infrastructure and commodity- related businesses, such as steel, power, infrastructure etc. But now, due to slump in both these sectors, the corporate profits have hit new lows. With low profits, the corporates are not able to repay their loans and their debts are rising at an alarming level. They have no other option other than to cut back investments.

The financial position of India’s public sector banks (PSBs) has deteriorated sharply over the past financial year. Gross bad loans at commercial banks could increase to 8.5 per cent of total advances by March 2017, from 7.6 per cent in March 2016, according to a baseline scenario projection by the Reserve Bank of India (RBI) in its Financial Stability Report. “The macro stress test suggests that under the baseline scenario, the gross NPA may rise to 8.5 per cent by March 2017,” the RBI noted in the report. “If the macro situation deteriorates in the future, the gross NPA ratio may increase further to 9.3 per cent by March 2017.” The central bank has been pushing lenders to review the classification of loans given by them as part of an Asset Quality Review (AQR). The resultant sharp surge in provisions for bad debts has eroded profitability, especially at state-owned banks, in recent quarters. The gross bad loans of public sector banks increased to 9.6 per cent as of March 2016, from about 6 per cent a year earlier, RBI data showed. The rise in gross NPA is mainly because of the AQR, RBI said in the report. The AQR conducted by the banking regulator found several restructured advances, which were standard in the banks’ books, that needed to be reclassified as non-performing. Since a large proportion of standard restructured advances slipped into the NPA category, the overall stressed assets ratio increased marginally to 11.5 per cent from 11.3 per cent in September. RBI said subsequent to the AQR, gross NPAs rose 79.7 per cent year-on-year in March 2016.

What are Non-Performing Assets?

The NPAs are assets that stop generating income for a bank. Bank’s assets mostly comprise of loans and when these loans are on the verge of default (that is, about to go bad), they are classified as NPA.

In India, a loan is classified as NPA, if the interest or any installment remains unpaid for a period of more than 90 days.

The gross NPAs in India were 5.1 % of total loans advanced by the public sector banks as of September 2015 and the stressed assets were 11% of total loans advanced by them.

What are stressed assets?

Stressed assets are NPAs plus restructured assets. Restructured loans are loans that have been converted to equity under the corporate debt restructuring scheme.

The high amount of NPAs in banks have hit their profitability as well, as banks have to make more provisioning. Banks have to set aside large funds as provisions to take care of the potential losses arising out of the loans that might go bad. NPAs are the reason why most banks reported losses in the last quarter.

Banks’ NPAs have been growing for a while now. It not only affects the balance sheet and profitability of banks but also limits credit availability to the corporate sector. This limited credit availability leads to further decline in private investment,

The Union budget of 2016 has allocated Rs 25000 crore towards recapitalisation of Public Sector banks. This is a necessary step to infuse capital into the Public Sector Banks. RBI has set March 2017 as the deadline for banks to clean up their balance sheets and strengthen their assets and has taken several measures to address the problem.

Solutions so far-

Indian banks’ pile of bad loans is a huge drag on the economy. It’s a drain on banks’ profits. Because profits are eroded, public sector banks (PSBs), where the bulk of the bad loans reside, cannot raise enough capital to fund credit growth. Lack of credit growth, in turn, comes in the way of the economy’s return to an 8 per cent growth trajectory. Clearly, the bad loan problem requires effective resolution.

Once an asset is recognised as a non-performing asset (NPA), banks must decide what to do with it. They have several options. One, they can try to seize the assets pledged by the borrower and sell these. This typically involves large losses on loans as the assets have to be sold at steep discounts to their book value.

Two, under the RBI’s Strategic Debt Restructuring (SDR) scheme, they can convert their loans into equity, acquire a majority stake in the firm, dislodge the promoters or management and bring in new promoters and management. While this happens in advanced economies all the time, the SDR scheme has not taken off in India. Indian banks do not have experience in running businesses till such time as new promoters are found. Nor do they have experience in locating promoters and management who can take over the stressed assets.

Three, banks can restructure the loans so that borrowers are able to service them. This involves stretching out the period of payment, or waiving a portion of the loans, or reducing the interest rate on loans, or some combination of these. In any restructuring, banks incur losses on the loans they have made. At PSBs, managers are open to the charge that they have favoured borrowers in a restructuring scheme and can invite action from the investigative agencies. In today’s environment, this has resulted in virtual paralysis at PSBs.

A fourth option for banks is to sell the NPA at a discount to an Asset Restructuring Company. This again involves a significant loss on loans when the transaction is made. But it has the effect of getting an NPA off the books of the bank or ‘cleaning up the balance sheet’. The bank’s capital is eroded to the extent of the loss. However, since 100 per cent of the loan has exited the balance sheet, the ratio of regulatory capital to assets — or what is called ‘capital adequacy’— improves. The bank now looks more attractive to investors. {The "bad bank" proposal is a variant of the fourth option. The idea is to transfer NPAs of banks, perhaps only PSBs, to the bad bank. The bad bank will manage these NPAs in suitable ways — some may be liquidated, others may be restructured, etc. Getting NPAs off the books will help the PSB management focus on new business instead of having to expend their energies on trying to effect recoveries. A bad bank will be better focused on the task of recovery. If it’s a private entity, it can also bring in superior expertise.}

Overall, RBI being the central bank and thereby a key regulator for the banking sector has tedious task at hand with respect to maintaining fiscal prudence within the banking sector. An innovative approach moving alongside an inclusive consensus of industry and subject experts will be a key requirement in dealing with this issue in future.

By: Abhishek Sharma