Insights into Editorial: Resolving India’s banking crisis
Non-performing assets (NPAs) at commercial banks amounted to Rs.10.3 trillion, or 11.2% of advances, in March 2018.
Public sector banks (PSBs) accounted for Rs.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. In 2007-08, NPAs totalled Rs.566 billion (a little over half a trillion), or 2.26% of gross advances.
The financial stability report released by the Reserve Bank of India has warned that the gross non-performing assets (GNPAs) of scheduled commercial banks in the country could rise from 11.6% in March 2018 to the GNPA ratio for public sector banks (PSBs) is posited to only inch lower to 14.6% by March, from 14.8% in September.
The Reserve Bank of India (RBI), acting in the belief that NPAs were being under-stated, introduced tougher norms for NPA recognition under an Asset Quality Review.
This puts at rest the hope of a bottoming out of the NPA crisis that has affected the banking system and impeded credit growth in the economy.
Origin of the present NPA crisis:
The origin of the crisis lies partly in the credit boom of the years 2004-05 to 2008-09. In that period, commercial credit (‘non-food credit’) doubled.
It was a period in which the world economy as well as the Indian economy were booming. Indian firms borrowed furiously in order to avail of the growth opportunities they saw coming.
Most of the investment went into infrastructure and related areas: telecom, power, roads, aviation, steel. Businessmen were overcome with exuberance, partly rational and partly irrational. They believed, as many others did, that India had entered an era of 9% growth.
Thereafter, as the Economic Survey of 2016-17 notes:
Many things began to go wrong. Thanks to problems in acquiring land and getting environmental clearances, several projects got stalled. Their costs soared.
At the same time, with the onset of the global financial crisis in 2007-08 and the slowdown in growth after 2011-12, revenues fell well short of forecasts.
Financing costs rose as policy rates were tightened in India in response to the crisis. The depreciation of the rupee meant higher outflows for companies that had borrowed in foreign currency.
This combination of adverse factors made it difficult for companies to service their loans to Indian banks.
Tightening norms made us clear in finding Exact Problem:
For every loan given out, the banks to keep aside some extra funds to cover up losses if something goes wrong with those loans. This is called provisioning.
Provisioning Coverage Ratio (PCR) refers to the funds to be set aside by the banks as fraction to the loans.
Provisioning basically means that the banks estimate that a particular borrower may not be able to pay back the loan in full and hence make a provision of the amount they could lose (as in that won’t be paid back to banks).
Banks start creating provisions on a loan given when the borrower starts defaulting on his repayment instalments.
Higher NPAs mean higher provisions on the part of banks. Provisions rose to a level where banks, especially PSBs, started making losses. Their capital got eroded as a result.
Capital from the government was slow in coming and it was barely adequate to meet regulatory norms for minimum capital.
Without adequate capital, bank credit cannot grow. Even as the numerator in the ratio of gross NPAs/advances rose sharply, growth in the denominator fell.
Both these movements caused the ratio to shoot up to a crisis level. Once NPAs happen, it is important to effect to resolve them quickly. Otherwise, the interest on dues causes NPAs to rise relentlessly.
Plans to Prevent such crises in Future:
We need a broad set of actions, some immediate and others over the medium-term and aimed at preventing the recurrence of such crises.
Wholesale privatisation of PSBs is thus not the answer to a complex problem.
One immediate action that is required is resolving the NPAs. Banks have to accept losses on loans (or ‘haircuts’).
They should be able to do so without any fear of harassment by the investigative agencies. The Indian Banks Association has set up a six-member panel to oversee resolution plans of lead lenders.
To expedite resolution, more such panels may be required. An alternative is to set up a Loan Resolution Authority, if necessary, through an Act of Parliament.
Second, the government must infuse at one go whatever additional capital is needed to recapitalise banks providing such capital in multiple instalments is not helpful.
Medium-term to Long-term Solutions:
PCA helps in increase profitability of banks through reduction of NPA. Unless, now they earn profit of it and also risky to lend to big borrowers as their liquidity is less because of high NPA.
So Prompt Corrective Actions helps to bank to improve their business for the foreseeable future instead of hurting their operations.
Over the medium term, the RBI needs to develop better mechanisms for monitoring macro-prudential indicators. It especially needs to look out for credit bubbles.
True, it’s not easy to tell a bubble when one is building up. Perhaps, a simple indicator would be a rate of credit growth that is way out of line with the trend rate of growth of credit or with the broad growth rate of the economy.
Actions needs to be taken to strengthen the functioning of banks in general and, more particularly, PSBs.
Governance at PSBs, meaning the functioning of PSB boards, can certainly improve.
One important lesson from the past decades experience with NPAs is that management of concentration risk that is, excessive exposure to any business group, sector, geography, etc. is too important to be left entirely to bank boards.
The task of accelerating economic growth is urgent. This is not possible without finding a solution to the problems that confront the banking system.
Succession planning at PSBs also needs to improve. Despite the constitution of the Banks Board Bureau to advise on selection of top management, the appointment of Managing Directors and Executive Directors continues to be plagued by long delays.
There is ample scope for improving performance within the framework of public ownership. It can be done. What is needed is a steely focus on the part of the government.
Overall risk management at PSBs needs to be taken to a higher level. This certainly requires strengthening of PSB boards. We need to induct more high-quality professionals on PSB boards and compensate them better.
India needs a safe and efficient banking system to service the needs of a growing economy. The RBI as well in addition to government part would do well to use the current opportunity to strengthen the banking system.