Gnawing away from inside

By Praveen Raman
In Banking & Finance
September 14, 2015

NPAs are fast becoming a nightmare for banking sector

NPA managementNPA OR the non-performing asset of a bank is defined as a credit facility in respect of which the interest and/or installment of principal has remained ‘past due’ for a specified period of time. To put it simply, an asset is tagged as nonperforming when it ceases to generate income for the lender.

Banks are technically always faced with the risk of default by the borrower in the payment of either principal or interest. This risk in banking parlance is termed as ‘Credit Risk’ and accounts where payment of interest and /or repayment of principal is not forthcoming are treated as Non Performing Asset. As per the Reserve Bank of India, an asset, including a leased asset, becomes non performing when it ceases to generate income for the bank. Existence of NPAs is an integral part of banking and every bank has some in its advance portfolio. However, the high level of NPA is a cause of worry to any financial institution. The NPAs in India’s financial sector are troubling the financial sector and policy makers alike from quite some time as their bulk has increased beyond a manageable limit. The NPA or bad loans of the public sector banks (PSBs) have increased to Rs 2.67 lakh crore at the end of March 2015 from Rs 2.16 lakh crore a year ago. There are enough indications that the NPAs of the PSBs as a percentage of the NPA of the whole system is increasing continuously. Gross NPA Ratio of the PSBs increased to 5.43% at the end of March 2015 as compared to 4.72% a year ago.

Public sector banks

Public sector banks are worst off in NPA management

What explains such a high NPA in system
The poor business environment is among the prime factors for rising NPAs. Business environment refers to economy, regulatory regime, legal system and political climate in which banks are operating. These factors include recession in the economy, sudden change in global & domestic markets, lack of conducive legal system for loan recovery i.e. inadequate legal provisions on foreclosure & bankruptcy laws and dilatory legal procedures in enforcing security rights. Additionally, lack of cohesive regulatory framework, political pronouncements like debt relief, Socio-political pressures on commercial credit decisions, vitiated loan repayment culture, policy reversal i.e. changes in governmental policies etc. are reasons for generation and increase of NPAs in the system because these tweaking of norms change the profitability structures for a very large amount of investment that has already been sunk in various venture. A typical example could be cancellation of Telecom & Coal mine licences, which could have been awarded wrongly in the first place.

But poor business sentiments, changing business environment and bad decision making on part of promoters explain only part of the problem. The other part is more non economical in nature and relates to how non financial considerations can impact financial  decision making. Indian financial institutions have long been misused for achieving political mileage and banks have been forced to spend money for commercially unviable projects. For Example, the government of India has given a massive wavier for rural debt almost every year, which invariably accentuates in election year.

Many poverty elevation programs failed on various grounds in meeting their objectives. The huge amount of loan granted under these schemes were totally unrecoverable by banks due to political manipulation, misuse of funds and non-reliability of target audience of these sections. Loans given by banks are their assets and as the repayment of several of the loans were poor, the quality of these assets were steadily deteriorating. Credit allocation became ‘Loan Melas’, loan proposal evaluations were slack and as a result repayment were very poor.

Another reason for a large buildup in the system is that banks had lent to projects a part of the economic package announced by
the government to avert a financial crisis in 2008. While easy money availability possibly averted a crisis, the ghost of financing unviable projects at that time has come to haunt banks now. State run banks are in worse shape as they were more invested in such projects.

The impact on lending behavior of banks
The rising NPAs have devastating effect on the economy. Its consequences are not only felt by the government that has to think in terms of keeping banks afloat, but also by banks whose lending habits are impacted. For one, profitability of the banks is hampered severely as the banks do not earn any income from NPAs, rather they incur cost for their maintenance and have to provide for future losses. It is reported that total net profit of all PSBs including the SBI fell sharply by 26.8 per cent to Rs 37,017 crore in the financial year 2014-15 compared to that during previous year. Furthermore, on the current NPA stock, as per estimates, banks are incurring a minimum loss of Rs 20,000 crores annually besides making provision of Rs.1 lac crores. Due to non-realization of NPAs, the credit flow to needy persons/sectors is held up as banks have become extra cautious.

Secondly, to compensate their interest loss in NPAs, to some extent banks are charging the good customers a higher rate of interest. Thus, the cost of credit i.e. interest rate goes up and consequently the high interest rate affects the viability of many running units.

Cleaning up the mess
For containing NPA at a manageable level, preventive as well as corrective steps are required. The preventive measures are those measures which prevent creation of fresh NPAs in banks. This will began by framing cohesive & conducive regulatory regime. For example, RBI should be more liberal in Income Recognition, Asset Classification (IRAC) norms when the economy is on downturn; particularly for those sectors which are severely affected due to economic slumps and political scam; such as coal based industries, infrastructure, textile, aviation, etc. Another area is improving loan repayment culture in the society by banning political loan waiver schemes and giving incentives for timely loan repayment. Lot of work need to be done on improving credit skills and credit monitoring tools and techniques of the bankers. Some borrowers are not putting or are withdrawing their capital/equity tactfully from the units/projects in connivance with various consultants/professionals such as chartered accountants, valuers, legal advisers, etc. There should be some legal mechanism for punishing those consultants who do not follow their legal ethics & values while submitting their reports to the bankers who rely on them for taking credit decision. On the corrective measures front, bankers should work harder on credit management. For revitalizing distressed assets in the economy, Reserve Bank of India has come up guidelines on Joint Lenders’ Forum (JLF) and Corrective Action Plan
(CAP) for taking prompt action for early identification of distressed assets and taking corrective actions on regularizing the accounts, revival of viable units, and recovery/ sale of unviable units after proper diagnosis of the problems. These guidelines should also be extended to existing NPA accounts for taking prompt action for revival/ recovery by lenders. For example, prior to above RBI guidelines, if any account under consortium/multiple banking arrangement has already been declared NPA by any lender, but it is standard & not being reported as SMA-2 by any other lenders, then that particular lender is not able to  take corrective measures for this distressed asset, as other lenders are not mandatorily compelled for such joint action.

Government steps in to recapitalize PSBs
The government has decided to infuse Rs 70,000 crore into ailing PSBs by 2018-19. In this direction, the government has decided to infuse capital to the tune of Rs 20,000 crore this fiscal, half of which will go to “weak” banks.

There are indications that infusion of capital could start as early as September. This money is likely to strengthen balance  sheets of banks reeling with high NPAs and bad loans. In his Union budget for the fiscal presented in February, Finance Minister Arun Jaitley had said that the government has earmarked slightly under Rs 8,000 crore for capital infusion purposes for the current year.

The amount was low and the banks needed more. Therefore, the government agreed to a further capital infusion but in April said that it will rank banks on their needs for more funds.

Public sector banks have served the country well, financing the industrialization since independence. They have also played a  significant social role by providing easy credit to agriculturists.

They need to be revitalized and made stronger so that they can continue to play their important role in the national economy and for that the menace of NPAs needs to be eliminated.