Bank NPAs: A 5Ws-2Hs Analysis

Banks in India have two types of assets: performing and non-performing assets (NPAs). With effect from March 31, 2004, NPA is a loan or an advance where, interest and / or instalment of principal remain overdue for a period of more than 90 days in respect of term loan; the account remains out of order for a period of more than 90 days in respect of an overdraft/ cash credit; the bill remains overdue for a period of more than 90 days in the case of bills purchased and discounted; interest and/ or instalment of principal remain overdue for two harvest seasons but for a period not exceeding two years, in case of an advance granted for agricultural purpose.

Conceptually speaking, a credit facility becomes an NPA when it ceases to generate income for a bank. An NPA can be sub-standard if it is pending for 12 months, doubtful if above 12 months, and lost if it is long-drawn with little hope of recovery. A loss of asset is one where loss has been identified by the bank, an internal or external auditor, or during Reserve Bank of India inspection.

As per the Reserve Bank of India rules, out of every Rs 100 deposited in a bank, Rs 4 is parked with the RBI, and Rs 19.5 in assets like bonds or gold. Almost a quarter of the money in the system can be retrieved in case of a contingency while the bank is free to lend the remaining Rs 76.5 to corporate or retail borrowers.

The interest gleaned on such loans is used to compensate the bank’s customers as interest payment, and the remainder is the bank’s profit. NPAs arise when banks lend to clients who default on their repayment, thereby leading the bank to become sick gradually. The Financial Stability Report, 2017, released by the RBI, states that India’s gross NPAs stands at 9.6 per cent, though Care Ratings finds NPAs at 11 per cent of total lending by public sector banks (PSBs). India has the second highest ratio of NPAs among the major economies of the world. Only Italy, with 16.4 per cent NPAs has more stressed assets. China, whose economic growth is largely fuelled by borrowings, has only 1.7 per cent NPAs, according to the International Monetary Fund (IMF). According to the former RBI Governor Raghuram Rajan, broad estimates show that Indian banks are currently burdened with bad loans that amount to more than Rs 9 lakh crore, public and private banks together.

Why do NPAs happen?

NPAs can rise due to several reasons, like when the borrowers diversify funds to unrelated business or engage in frauds. There can be lapses by the bank during due diligence. Often there are business losses due to changes in business/regulatory environment. There are evidences of a lack of morale among the borrowers, particularly after government schemes which had written off earlier loans.

Then, there are cases of global, regional or national financial crisis which results in erosion of margins and profits of companies, therefore, stressing their balance sheet which finally results into non-servicing of interest and loan payments. The general slowdown of the entire economy is another reason. For example after 2011 there was a period of slowdown in the economy which resulted in faster growth of NPAs. There can also be a slowdown in a specific industrial segment, therefore, companies in that area bear the heat and some may become NPAs. It has happened in the construction industry.

Unplanned expansion of corporate houses during the boom period and loan taken at low rates later being serviced at high rates, therefore, can result in NPAs. Also, NPAs can be due to maladministration by corporate houses, for example, wilful defaulters. Misgovernance and policy paralysis in borrowing houses hamper the timeline and speed of projects, therefore, loans become NPAs. The infrastructure sector, for instance, had been affected by bad loans and lack of decisions both at government and corporate levels. Severe competition in any particular market segment, for example the telecom sector, can also lead to stress. Delay in land acquisition due to social, political, cultural and environmental reasons can result in NPAs. There are cases of bad lending practices in case of Kingfisher and Nirav Modi or Geetanjali jewellery cases, which are non-transparent ways of giving loans.

NPAs can also be due to natural reasons such as floods, droughts, disease outbreak, earthquakes and tsunami. Further, there are cases of cheap import due to dumping that cause business losses for domestic companies. For example, the steel sector in India.

Political decision-making, formal and backdoor, are a major reason for corporate NPAs. The current Indian government had no hesitation to write off Rs 2.41 lakh crore in the last three years, and gross NPAs stand at Rs nine lakh crore now – it was around Rs three lakh crore in 2014.

Sanjay Das, secretary, All India Bank Officers Confederation (AIBOC), West Bengal, notes that for the last four years, public sector banks have been earning operating gross annual profits ranging from Rs 1.3 lakh crore to Rs 1.6 lakh crore, but net profit is wiped out due to the bad loans, given not at the whim of employees and the faulty provisioning norms, but through political decisions.

RBI data of March 31, 2018, shows NPAs of public sector banks add up to Rs 6.41 lakh crore, of which corporate industry NPA is around Rs 4,70,084 crore (73 per cent), agriculture sector NPA is Rs 57,021 crore (9 per cent), services sector NPA is Rs 84,686 crore (13 per cent), and retail sector NPA is around Rs 23,795 crore (4 per cent).

Who are responsible for its accumulation?

First, there is a nexus between manipulative borrowers and public sector bank officials, often with political blessings, who rip off public sector banks, witnessed recently in the Punjab National Bank (PNB) fraud at the Fort branch in Mumbai where diamond merchant Nirav Modi allegedly colluded with branch officials for several years to hoodwink the bank.

Second, there are farm loans, whose waivers irk copybook economists but are mercifully not being discussed much this year, partly because general elections are close and mostly because farmers pale in comparison to the fat cat borrowers.

Former RBI Governor Rajan told recently, “Too many loans were made (given) well-connected promoters who have a history of defaulting on their loans (c)... Public sector bankers continued financing promoters even while private sector banks were getting out (financing the said promoters).”

He also blamed public sector banks for inadequate due diligence before and after handing out loans. “Public sector bank monitoring of promoter and project health (for which loans were sought) was inadequate...Banker performance after the initial loans were made (was) also not up to the mark (sic).” Raghuram Rajan’s recent note to the parliamentary committee makes it abundantly clear how many corporate borrowers have gamed the system, both in obtaining loans as well as in the resolution process.

It is important to note that the Corporate Industry Loans (73 per cent of all NPAs) are sanctioned by government appointed Board Level Executives to Industry like Bhushan Steel, Lanco Infra, Essar Steel, Amtek, Monnet Ispat, Reliance, Adani groups, and to people like Nirav Modi, Vijay Mallya, et al. Agriculture NPA (9 per cent) is mostly due to farm loan waiver policies by newly-elected governments just before or after elections, and so such borrowers misuse loans. Services NPA (13 per cent) is mostly like MUDRA loan, where the current central government bars banks from taking collateral, and hence banks cannot recover and the borrowers happily default. Retail NPA, accounting for less than 4 per cent of all NPAs, is the only NPA where a common branch level banker makes a sanction in the form of housing, car, personal loan, et al.

When do NPAs happen the most, and why are they bad for the economy?

The RBI’s Financial Stability Report names the basic metals and cement industries as the most indebted, with 45.8% and 34.6% stressed assets respectively. Despite the recent GDP numbers which point to lukewarm growth, the metals industry continues to be hamstrung by slow demand and cheaper imports. The construction, infrastructure and automobile industries also account for a sizeable chunk of banks’ NPAs.

According to ratings agency CARE, as of June 2017, State Bank of India leads the list of scheduled banks with the highest NPAs with Rs 1,88,068 crore of stressed assets. Punjab National Bank and IDBI Bank follow suit with Rs 57,721 crore and Rs 50,173 crore of gross NPAs respectively. Private lenders like Kotak Mahindra Bank and HDFC fare better with only 2.58 per cent and 1.24 per cent gross NPAs, while the State Bank of India, which is saddled with most stressed assets in absolute terms, has a gross NPA ratio of 9.97 per cent.

Data collected by the Ministry of Statistics and Programme Implementation (MOSPI) and compiled by the World Bank reveals that economic growth tapers off with a spike in the bad loan ratio. While economic output has been laggard over the past few quarters owing to disruptive policies such as demonetisation and the implementation of the goods and services tax (GST), the lacklustre performance of India Inc has pulled down banks with greater defaults from corporate clients.

The gross NPA ratio has spiked from 5.884 per cent in 2015 to 9.6 per cent in 2017 while economic growth has slumped in the corresponding period.

NPAs make the banks, the lenders suffer lowering of profit margins. Stress in banking sector causes less money available to fund other projects, therefore, negative impact on the larger national economy. Higher interest rates are imposed by the banks to maintain the profit margin. There can be redirecting funds from the good projects to the bad ones. As investments got stuck, it may result in unemployment. In the case of public sector banks, the bad health of banks means a bad return for a shareholder which means that government of India gets less money as a dividend. Therefore, it may impact easy deployment of money for social and infrastructure development and results in social and political cost. Investors do not get rightful returns.

Both the banks and the corporate sector have stressed balance sheet and causes halting of the investment-led development process. NPAs related cases add more pressure to already pending cases with the judiciary.

How is this being tackled within the given banking system in India?

Rajan said that the RBI could have started the asset quality review (AQR) process earlier than it did and that it could have been “more decisive in enforcing penalties on non-compliant banks”. The process of stricter monitoring has started recently.

Joint Lenders Forum was created in 2014 by the inclusion of all PSBs whose loans have become stressed. It is present so as to avoid loan to same individual or company from different banks.

It is formulated to prevent the instances where one person takes a loan from one bank to give a loan of the other bank. The Mission Indradhanush framework, 2015, created for transforming the PSBs, represents the most comprehensive reform effort undertaken since banking nationalisation in the year 1970 to revamp the Public Sector Banks (PSBs) and improve their overall performance by ABCDEFG.

How can NPAs be tackled innovatively?

The need of the hour to tackle NPAs is some urgent remedial measures. This should include technology and data analytics to identify the early warning signals, a detailed mechanism to identify the hidden NPAs, development of internal skills for credit assessment within the banking system, and forensic audits to understand the intent of the borrower.

Raghuram Rajan used the term “non-cooperative defaulter” to describe corporate bigwigs who can’t or won’t pay back the loans they took. Arvind Subramanian speaks now of “stigmatised capitalism” that stops the government from reformist solutions to the NPA problem.

Today, without a framework for bankruptcy and orderly resolution for financial firms, India faces the risk that if a large private sector bank goes bankrupt, there is no legal way of dealing with it other than to force a public sector bank or insurance company like the Life Insurance Company to buy it out. To serve the growing needs of the economy for debt, equity, payment systems, and innovations in financial products and services it is required that regulatory reform is undertaken with much greater speed.

A corporate bond market is the ideal solution for freeing banks and businesses from this eternal cycle of bank loans and NPAs. The idea remains still-born despite numerous committees recommending it. The fortunes of the market are currently hostage to an inter-regulator turf battle. There are no easy solutions for NPAs; at least not till April 2019.