By Disha Rawal
The Reserve Bank of India on December 22 warned banks about their persisting asset quality problems. It said that the ongoing process of corporate deleveraging and the stretched balance sheets of Public Sector Banks (PSBs) continue to pose a downside risk to growth in the immediate future.
Efforts to mitigate Indias twin balance sheet problem have been continuing for a long time now. The biggest push came in October as the government announced a 2.11 lakh crore recapitalization package for banks. Stock markets gave a cheerful response to this announcement with the Nifty PSU Bank Index shooting up by 30 percent. However, in the light of this mega revitalization scheme, it is imperative to understand the problems that Indias burgeoning Non-Performing Assets (NPAs) load poses to growth prospects, and what the roadmap to recovery could possibly look like.
The size of the problem
Despite continued efforts to revive the banks, NPAs still pose a huge burden on the banking system, especially the PSBs. The stressed asset ratio indicates the number of impaired assets to the total loan amount. Indias overall stressed asset ratio is 9.1 percent, with 80 percent of these NPAs located in PSBs, where the figure stands at an enormous 12 percent. Indias stressed asset problem is the largest among emerging markets except for Russia.
Why are NPAs still a problem?
The excessive burden of NPAs poses challenges on two fronts. Banks are supposed to maintain certain capital levels against credit. With limited recoveries of loans, there is a looming capital insufficiency which impacts banks inability to extend credit. This has also led to risk aversion on the banks part.
With regards to corporations, there is a pile-up of borrowings which cannot be refinanced since banks are unwilling to lend to these companies. 40 percent of NPAs are concentrated with companies that don’t earn enough to make their interest payments.
What makes this problem harder to solve is that most of the NPAs are concentrated in large cases. This reduces the number of cases, but larger NPAs are harder to resolve.
Stressed assets have hit PSBs the worst. The demand side in the market for loans is quite robust in India. Thus, financial institutions have benefitted at the cost of PSBs by contracting their loan books, as they are taking advantage of the absence of PSBs in the lending market. Bond markets are also absorbing loans.
Why are institutional mechanisms unsuccessful?
Cases of NPAs are redirected to the National Company Law Tribunal under the Insolvency and Bankruptcy Code. However, the recovery rate has reduced from 40 percent in 2009 to a dismal 20.9 percent. This has been explained by PSBs lukewarm sale of stressed assets. Typically, the bank is required to take over a share of the ownership of the company, auction off assets and recover their loans. However, this requires some hard decision making which is not taking place. Another factor is that banks are unwilling to sell off their assets at discounted rates.
Companies are themselves engaging in deleveraging their bad debt. However, this process has itself been quite slow, but steady. Deleveraging has been constrained by the unavailability of credit.
Asset Reconstruction Companies perform the crucial function of taking over bad debts and making them viable. However, the performance of these companies has been poor in this scenario despite a favourable regulatory environment.
The recapitalization package is expected to kick in with the coming of the next year. However, that scheme also has its issues in the form of the moral hazard of companies being left off the need to pay back their loans and banks re-engaging in unsustainable lending. This leads us to look at other issues which are broader and fundamental in nature.
The bigger picture
The dismal performance of PSBs has been brought to the fore by this crisis. Many banks have been stripped off their capital allowances by the central bank because of their non-performance. If this continues, the recapitalization package could lead these banks to go back to the old practices which led to this crisis. Thus, a change in the top management of these banks is required.
More fundamentally, critics are questioning if the size of Indias public sector is actually justified by its efficiency. Narendra Modi had once said, “The government has no business being in business. Indeed, between 2010 and 2014, the market value of private sector banks rose by about $30 billion, while the market value of public sector banks (PSBs) simultaneously fell by about $30 billion. This indicates a deeper problem in the business set up.
The road to recovery
Firstly, it is important to aid buyers of stressed assets. Tax concessions must be offered which can incentivize purchase. One reform that has been suggested emphatically is setting up a central agency which could take over the bad debts from indecisive banks and buy stressed companies. This would mark a shift from the decentralized approach currently being taken, and reduce the dependence on asset reconstruction companies.
Credit sufficiency is a central requirement of a growing economy. A revival of co-operative banking and a renewed emphasis on micro-financing has been suggested as alternatives to large banks, especially in order to provide loans to women, illiterates and communities with no access to banking services.
This recovery project must be aggressively pursued. Companies shouldnt be let off under the recapitalization program, rather, they should be disallowed from participating in auctions and brought into the loop of loan recovery. If a banking sector reform is needed, so is a corporate sector reform, especially of promoters with heavy political linkages.
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