Banking is an inherently hugely profitable business. To get a sense, all that one needs to do is to look at the hundreds of thousand crore that a bank gets in savings account on which it pays a meager 3.5%-4% interest and earns a minimum of 10% by lending. Even on the funds it garners by way of term deposits [6.25%-7.5% depending on period], there is room for making good money.
Yet, Indian banks especially public sector banks [PSBs] have posted huge losses in recent years leading to corresponding erosion in their capital and resultant impairment in their capacity to continue with lending. 11 out of a total of 21 PSBs were even put under Prompt Corrective Action [PCA] framework that meant restriction on their deposit taking and lending activities.
This may sound anomalous but it happened. An overriding reason is mammoth sums owed by the industrialists/businessmen to PSBs which were not paid back. These dues known as non-performing assets [NPAs] in common parlance are the offshoot of indiscriminate lending during 2008-2014 to those patronized by the then ruling establishment without conducting due diligence.
If, a bank has a major slice of funds simply going down the drain [forget no interest, even the principal amount is not recovered], even high margin [difference between lending rate and cost of funds] won’t be of any help in keeping the balance sheet in good shape. So, the banks plunged in to a crisis situation.
Modi has initiated all necessary measures viz. legislative, administrative, investigation and prosecution to make an onslaught on the NPAs. At the core is Insolvency and Bankruptcy Code [IBC] – a law enacted by his government 2 years ago.
The architecture put in place to deal with insolvency and bankruptcy under the new law strikes all the right nodes and provides for timely corrective action. From the day an account becomes NPA, the banks get6 months to either get the defaulting borrower pay up or his assets be transferred to new owner who can pay up. On its expiration, the case is referred to National Company Law Tribunal [NCLT] which gets6 months to complete the resolution process; extendable by 3 months.
This keeps the stakeholders viz. committee of creditors [CoC], bidders/suitors and judicial authorities on the tenterhooks so that the capital embedded in the enterprise is conserved and resolution process yields maximum value. The time limit of one year [plus 3 months in special cases] forces them to deliver results expeditiously.
Since IBC coming in to force, banks have recovered over Rs 350,000 crore including Rs 200,000 crore settlement of 4,452 cases at the pre-admission stage and Rs 150,000 crore under IBC [Rs 80,000 crore already recovered and Rs 70,000 crore expected to be recovered during remaining months of current fiscal]. This is over one-third of the total banks NPAs of about Rs 1000,000 crore.
The government has also made drastic changes in the eco-system of lending with emphasis on due diligence, transparent processes, and prompt reporting of large defaults. This has reined in fresh slippages. Together with recoveries, this has helped in reducing gross NPAs from 11.5% as in March, 2018 to 10.8% in September, 2018. This will further decline to 10.3% by end of current fiscal.
The NPA scenario is expected to show further sustainable and substantial improvement. The confidence stems from the fear IBC processes put in the mind of a defaulting borrower that he will lose ownership and control of the company if he does not turn up to clear the dues. So, he will pay. Further, once the creditor files a petition before the NCLT, debtors pay at the pre-admission stage to avoid declaration of insolvency.
Undoubtedly, Modi – government has brought in a revolutionary reform that not only makes a huge dent on existing NPAs but also nips in the bud any chances of fresh build up. It forces the debtor to chase the creditor instead of the latter chasing the former [as used to happen under earlier dispensation] to get the dues cleared.
However, for the momentum to sustain, India needs a committed leadership which requires that the present dispensation should continue. Things could be difficult if a new regime [say, a coalition government led by Congress] takes charge in May 2019. Then, the new eco-system for lending by banks could suffer a serious set-back and effective implementation of IBC compromised.
To reduce vulnerability of the system to political leadership, there is an urgent need for giving autonomy to PSBs and minimizing political and bureaucratic interference in their working. For this, the union government should relinquish majority control by lowering its share holding to less than 50%.
In this regard, the NDA-dispensation under the then, prime minister Vajpayee [1998-2004] had mooted reduction in government’s share in PSBs to less than 50% initially and eventually to 33%. Recently, a committee set up by the Reserve Bank of India [RBI] under P Nayak also recommended reducing its share to below 50% and housing the residual shares in a holding company.
Being election time, a drastic decision such as this will have to wait till a new regime is installed. Hopefully, if Modi is voted to power yet again, he should take the initiative in this direction. To begin with, the government may transfer its equity holding in PSBs and all associated rights and responsibilities – those go with it – to a banking investment company [BIC].
After the banks turn robust and healthy, it should consider at the appropriate time [when their market capitalization improves] divestment of majority holding. The shares should be so distributed as to avoid concentration of holding in a few hands to ensure that the management has greater accountability to the public.
This indeed is the way forward for enabling the banking sector meet the credit needs of Indian economy on a high growth trajectory and for creating more jobs.