By Satyajit Mishra
In the midst of the financial crisis in 2008, India slackened its rules on how banks were allowed to deal with bad debts. These were policies designed to give room to borrowers in temporary difficulty because of a shock that originated from the American housing market. Several state-owned banks have exploited the loopholes in these rules by ignoring basic accounting conventions and disclosure policies.
Bank loans are primarily classified under two heads-performing and non-performing. If its a non-performing loan, lenders must build up reserves against potential losses. However in 2008, the RBI permitted the use of an intermediate category of restructured loans. These are new loans that replace the original loan and are paid over a longer period, usually with lower installments. Along with allowing these risky loans to be restructured, no provisions were allowed to be made against them.
Needless to say, such lax policies are bound to attract abuse. Indias state-owned banks are responsible for the majority of the loans where bad debts are overwhelmingly concentrated.
When a restructured loan does not perform well, it deteriorates and becomes non-performing. In the case of State Bank of India, such non-performing loans have risen to 25%. Problem loans (loans that have been due for over 6 months) which include both non-performing and restructured loans have reached 9% of the total loans. Surprisingly the bulk of declared problem loans are to farmers and small firms. The most strained parts of the economy such as massive infrastructure and property projects are not reflected in this figure. Many that are in financial trouble are still classed as performing. The troubles of family run conglomerates too are yet to be accounted for in these numbers. Despite their weak state, the ten most indebted family run conglomerates are still classified as performing.
A major issue facing several indebted firms is modest operating profits. These profits are too small to even pay the interest costs. Despite this, over 80% of such indebted firms are still classified as performing. Such bad debts will eventually weigh down state banks.
By ignoring the basic accounting convention of the principle of conservatism, banks have created ridiculously low levels of reserves against such problem loans. Additionally, they have failed to disclose that they have done so. This raises concerns regarding possible future funding from external sources. Institutional investors will take note of this and are likely to park their money elsewhere. To make matters worse, banks are already in poor shape and a cash-strapped government is unlikely to inject more money into state banks.
Back in May, the RBI announced it would toughen the rules by abolishing the restructured category of loans by April 2015. However, a point that has not been highlighted is that the infrastructure and property projects that suffer delays would still be allowed to be treated as restructured. The RBI has laid this escape clause in order to prevent further choking of investment in a struggling economy.
For India to recover from her sluggish growth rates, private banks need to rise up to the challenge and take more market share. This needs to be done while following all the necessary legal regulations and complying with accounting standards. Lending will need to be done swiftly while maintaining its current magnitude. State-banks need to cut back on problem loans and solve the issue at hand promptly, failing which the bulk of Indias lending from the financial backbone of the country will be slow and in turn hamper the Indian growth story.
Currently in 3rd year of B.Com under Calcutta University specializing in accounting and finance. Also pursuing Chartered Accountancy. Reading research and analysis of the global economy, political matters that influence our economic decisions, game theory and strategies in war, strategy formulation and implementation and contemporary issues in marketing interest him a lot.