The banking system in India is considered to be a rock solid foundation of its economy. Its ‘strength’ and ‘resilience’ was tested during the global financial crisis of 2008 when India survived the mayhem that gripped most parts of the world.
However, a glance through the latest Financial Stability Report (FSR) would make us believe that cracks have started developing in this foundation. The Rs 81 lakh crores (US$ 1.3 trillion) banking industry is facing heightened risk.
Gross non-performing assets (NPA) – a euphemism for bad loans – of 40 listed banks increased 37% to Rs 229,000 crores (US$ 37 billion) during the second quarter ending September, 2013. Besides, banks have restructured loans worth Rs 400,000 crores (US$ 64 billion).
Restructuring of a loan (depending on profile, this may involve reduction in interest rate, rescheduling repayment or even exonerating portion of principal amount) is done to prevent it from turning ‘bad’. The line between a restructured loan and a bad one is very thin.
Putting the two together, we are talking of a whopping US$ 101 billion – or around 8% of the size of banking industry – loans landing in a vulnerable zone!
A prime source of vulnerability is practice of a bunch of banks lending huge sums to large corporates. If, a corporate defaults in paying to even one bank, reverberations are felt on all banks. RBI measures this through so called banking stability index (BSI).
Thus, if bad loan for a large bank increases by 100%, additional losses to banking system would increase by 27% of total capital. Failure of a large corporate group could result in total loss of over 60% of banking system’s capital.
Invariably, Indian banks are extremely liberal in lending to large industrial houses. Their accommodating stance especially of public sector banks (PSBs) gets a fillip from Government ever desperate to use them for becoming a partner in process of development.
Call it spill over of liberalization and reform era or abdication of its own responsibility in funding development, Government loses no opportunity to use public deposits with PSBs for giving largesse to a handful of private sector albeit in the name of growth.
This syndrome has even got impregnated in the lending norms too. Thus, a bank’s exposure to a single borrower can go up to 25% of the bank’s total capital, while its group exposure limit can go up to 55% of total bank’s total capital.
These limits are much higher than international standards. The Government/RBI may justify these in the context of the need to catapult Indian economy to a high growth trajectory. But, this is clearly an un-sustainable approach.
During 12th plan (2012-13 to 2016-17), Government/Planning Commission estimated investment requirement for infrastructure viz., road, port, rail, power etc to be US$ 1 trillion. Of this, 50% is to come from the private sector mostly through PPP (public-private- partnership) mode.
Scratch the surface and one will find that majority of infrastructure projects under implementation by large corporate groups are heavily leveraged. These involve substantial funding by PSBs mostly under consortium arrangements. No wonder, lending norms have been liberalized to accommodate this.
Heavily leveraged projects suffer from an ‘inherent’ inertia. With a lower component of own funds, it is too much to expect a high degree of commitment to timely implementation. Things get compounded by bureaucratic delays in granting various approvals viz., environment clearances, land acquisition etc.
The proof of pudding is in eating. This deadly combination besides slow-down in economic growth (this may have upset calculations in some sectors like highways, real estate etc) has led to proliferation of NPAs and restructured loans in the last 5 years.
According to RBI, 5 sectors viz., infrastructure, iron and steel, textile, aviation and mining account for about 24% of total advances of scheduled commercial banks (SCBs) but, these have around 53% share in their total ‘stressed’ advances.
Finance Ministry/RBI have come out with a novel idea to prevent a loan from going bad. As per existing norm, a loan is treated as bad if a borrower is unable to pay dues within 90 days. The proposal is to put things under constant watch and ascertain status prior to that say, at end of 30 days & 60 days.
Thus, if due are not paid at the end of 60 days, the bank should take this as an indication of creeping problems and initiate necessary steps instead of waiting till expiry of 90 days. The relevant data should be forwarded to a central repository for sharing by all banks.
These steps tantamount to adopting a ‘precautionary’ principle. A person should take precautions to prevent incipient sickness instead of going to doctor when he actually falls sick. This may be helpful in certain situations, but remains fall short of making a dent on endemic problem of stressed assets.
How does a bank address a situation where loan was given to a project without undertaking due diligence? How does it remedy a situation where project does not take off for several years due to delays in getting approvals?
How does bank cope up with a recalcitrant borrower who merely sits on project and diverts funds to some other activity? How does bank deal with NPAs that arise largely due to Government forcing it to share subsidies that it intends to give to target groups?
All such scenarios are best characterized as ‘babies born sick’! These cases of stressed assets (ironically, bulk of NPAs owe their origin to these ‘generic’ factors) are impossible to deal with the above mentioned stereo typed idea.
If, RBI and Government are really concerned about health of Indian banking industry and ensure that this pillar remains in tact, they should look for structural solutions.
Foremost, PSBs must be allowed to run professionally without any interference from Government. Finance Ministry must keep its hands off their Boards. Directors representing GOI (invariably bureaucrats) may only contribute to decision making process instead of carrying diktats from the Ministry.
Since, almost all infrastructure projects require approvals and statutory clearances from authorities in central Government and states and huge funds lent by banks are at stake, they need to be extra alert and ensure that speedy approvals & clearances are granted.
Government should refrain from using banks to discharge a function which is strictly its own responsibility. Thus, if it wants to give subsidy to state electricity boards (SEBs)/power distribution companies (PDS) or loans to priority sectors at concessional rates, money should come from the budget.
The viability of capital intensive projects like in power, oil & gas, fertilizers etc depends on policies and tax regime. Government must ensure that policy environment is ‘stable’ and ‘conducive’. Retrospective changes must be avoided.
The exposure limits of banks need to be brought down to global benchmarks. This will prevent too much pumping of resources in to few pockets and thus reduce element of vulnerability. Borrowers will be forced chip in more of their own money and manage projects better for safety of bank funds.
RBI Governor & Finance Minister should not merely express concern. They need to get in to action mode.