NPAs may soar to 20-yr high

Indian banks’ bad loan ratio is expected to climb to the highest level in more than 20 years as a protracted lockdown has severely disrupted business operations and left millions of people jobless, crimping their ability to repay loans.

Here is why the NPA problem is such a big problem to Indian banks, especially PSBs.

• In March 2018, non-performing assets (NPAs) at commercial banks amounted to ?10.3 trillion, or 11.2% of advances.
• Public sector banks (PSBs) accounted for ?8.9 trillion, or 86%, of the total NPAs.
• The ratio of gross NPA to advances in PSBs was 14.6%.
• These are levels typically associated with a banking crisis.
• For example, in 2007-08, NPAs totalled only ?566 billion (a little over half a trillion), or 2.26% of gross advances!

The current trend is that the increase in NPAs since 2008 has been staggering.

• NPA or Non-Performing Asset is those kinds of loans or advances that are in default or in arrears. In other words, these are those kinds of loans wherein principal or interest amounts are late or have not been paid for a period of 90 days. These are also the kinds of loans where the lender considers the loan agreement to be broken and the receiver of the loan is unable to pay back the loan amount.
• How are NPA classified?
• Substandard assets: Assets which has remained NPA for a period less than or equal to 12 months.
• Doubtful assets: An asset would be classified as doubtful if it has remained in the substandard category for a period of 12 months.
• Loss assets: As per RBI, “Loss asset is considered uncollectible and of such little value that its continuance as a bankable asset is not warranted, although there may be some salvage or recovery value.”

• Non-performing assets may rise 4 percentage points to 12.5% of total advances by March 2021, the highest since the year ended 31 March 2000, under the baseline stress scenario, the Reserve Bank of India said in its semi-annual Financial Stability Report.
• The central bank warned that if the economic conditions worsen further, the ratio may soar to 14.7% under the very severely stressed scenario.
• Deterioration in asset quality will put further pressure on lenders who are struggling with subdued credit demand amid the coronavirus pandemic and a mountain of bad loans.
• Banks are preparing for a further worsening of asset quality by raising funds to bolster their capital buffers. The end of a moratorium on loan repayments, aimed at providing relief to businesses and individual may see many loan accounts turn non-performing.
• The rise in bad loans may further reduce the ability of banks, especially the weak ones, to extend credit, and the government may have to infuse more funds into state run banks to build stronger buffers that can absorb loan losses.
• The RBI cautioned that the impact of the loan moratorium is still evolving and the exact extent of its impact on asset quality is difficult to ascertain accurately.
• Among commercial banks, the gross bad loan ratio of state-run banks could increase to 15.2% under the baseline scenario, the highest among its peer groups.
• Indian state-owned banks were just coming out of the last bad loan crisis and cleaning up their books when the coronavirus pandemic struck.
  
  

• Some of the factors leading to the increased occurrence of NPAs are external, such as decreases in global commodity prices leading to slower exports. Some are more intrinsic to the Indian banking sector.
• A lot of the loans currently classified as NPAs originated in the mid-2000s, at a time when the economy was booming and business outlook was very positive. Large corporations were granted loans for projects based on extrapolation of their recent growth and performance.
• With loans being available more easily than before, corporations grew highly leveraged, implying that most financing was through external borrowings rather than internal promoter equity. But as economic growth stagnated following the global financial crisis of 2008, the repayment capability of these corporations decreased.
• This contributed to what is now known as India’s Twin Balance Sheet problem, where both the banking sector (that gives loans) and the corporate sector (that takes and has to repay these loans) have come under financial stress.
• When the project for which the loan was taken started underperforming, borrowers lost their capability of paying back the bank. The banks at this time took to the practice of ‘ever greening’, where fresh loans were given to some promoters to enable them to pay off their interest. This effectively pushed the recognition of these loans as non-performing to a later date, but did not address the root causes of their unprofitability.
• Further, recently there have also been frauds of high magnitude that have contributed to rising NPAs. Although the size of frauds relative to the total volume of NPAs is relatively small, these frauds have been increasing, and there have been no instances of high profile fraudsters being penalized.

• The measures taken to resolve and prevent NPAs can broadly be classified into two kinds – first, regulatory means of resolving NPAs per various laws (like the Insolvency and Bankruptcy Code), and second, remedial measures for banks prescribed and regulated by the RBI for internal restructuring of stressed assets.
• The Insolvency and Bankruptcy Code (IBC) was enacted in May 2016 to provide a time-bound 180-day recovery process for insolvent accounts (where the borrowers are unable to pay their dues).
• Under the IBC, the creditors of these insolvent accounts, presided over by an insolvency professional, decide whether to restructure the loan, or to sell the defaulter’s assets to recover the outstanding amount.
• If a timely decision is not arrived at, the defaulter’s assets are liquidated. Proceedings under the IBC are adjudicated by the Debt Recovery Tribunal for personal insolvencies, and the National Company Law Tribunal (NCLT) for corporate insolvencies.
• SARFAESI Act: It allows banks and other financial institution to auction residential or commercial properties (of Defaulter) to recover loans.
• Indradhanush plan: To revamp or improve the functioning of public sector banks. Indradhanush mainly focuses on systemic changes in state-run lenders, including a fresh look at hiring, a comprehensive plan to de-stress bloated lenders, capital infusion, accountability incentives with higher rewards including stock options and cleaning up governance.

• Improving credit risk management- This includes credit appraisal, credit monitoring and efficient system of fixing accountability and analyzing trends in group leverage to which the borrowing firm belongs to
• Sources/structure of equity capital-Banks need to see that promoter's contribution is funded through equity and not debt.
• Banks should conduct necessary sensitivity analysis and contingency planning while appraising the projects and it should built adequate safeguards against such external factors.
• Economic Survey has proposed 4 steps with the name of 4Rs for resolution of NPA crisis.4 Rs refer to Recognition, Recapitalization, Resolution, and Reform.
  • Recognition – Banks must value their assets accurately as far as possible
  • Re-capitalization – Banks’ capital position must be safeguarded via infusions of equity
  • Resolution– The underlying stressed assets in the corporate sector must be sold or rehabilitated
  • Reform –future incentives for the Private Sector and corporates must be set-right to avoid a repetition of the problem

The COVID-19 pandemic has severely affected the global economy. The Indian economy is further expected to undergo a difficult economic situation in the coming months. Subdued demand and NPA issues are likely to hold back growth in corporate banking. Hence, concerted efforts should be taken at this time by both RBI and the government to keep the financial system and financial markets sound, liquid and smoothly functioning so that finance keeps flowing to all stakeholders, especially those that are disadvantaged and vulnerable.