How the RBI can save public banks from Non-Performing Assets

By Indroneel Das

The Indian banking industry has been facing the Non–Performing Asset (NPA) heat for a while now. While the industry seems to be bearing the brunt of having stressed assets, it is the Public Sector Banks (PSB) of the country that are showing more worrisome signs. PSBs have larger exposures to what is generically termed ‘bad loans’, and every quarter, more skeletons seem to tumble out of the closets of a few PSBs, pushing the Gross NPA ratios higher. The NPA wound is hurting the banking industry at many different levels.

Corporate lenders adding to the quicksand

First of all, corporate lenders categorized as large borrowers (ones with borrowings in excess of Rs. 5 crores) have increasingly defaulted over the last two to three years. Also, banks have to prepare a ‘watch list’ regularly which names all the loans and borrowers that the bank feels, need regular monitoring because the probability of default on these specific loans is higher.

As if the rising NPAs weren’t enough on their own, it is even more alarming that a significantly large proportion of new NPAs reported every quarter are coming from borrowers who were on this watch list. This indicates that banks haven’t yet been able to crack a more failsafe way of detecting and monitoring potential bad loans and defaulters. While private-sector banks seem to be dealing with NPA resolution more effectively, some PSBs are struggling to contain, forget resolve, their NPAs.

Difficulty in maintaining ‘balance’

There is a balance sheet specific reason as to why the PSBs are struggling more, and there are a few mechanisms by which the government and the RBI can help these PSBs fight the fire with urgency.

Any bad loan can be resolved in only one of two ways- either the money is recovered to whatever extent possible, or the loan is written off. In the specific case of our PSBs, most NPAs are in that category because any hope of recovery is not very logical anymore. This leaves only the second route- taking hits for the bad loans. Provisioning heavily for the bad loans, in line with near-term expectations, could help slowly, but steadily, get a grip of the reality and write off the bad loans. Provisioning, however, eats into the bottom line of the bank and hits the balance sheet quarter after quarter, as long as heavy provisioning continues.

A bank’s balance sheet is all about its assets, i.e. its creditors, which give them the interest income that they survive on. When a bank provisions for NPAs, it is basically accepting that certain loans may not only no longer be able to service their interest payments, but may also default on principal repayments. This means, every quarter and every year, the income statement is prepared for this write-off, by ‘provisioning’ for these bad loans or NPAs.

The bottom line drops on account of these provisions and the balance sheet is impacted every time the bottom line is hit and each time the assets on the balance sheet take a beating. For many PSBs, the extent of provisioning is so much that it pushes their otherwise profitable income statement into losses. So, provisioning is an extremely painful and long drawn process.

But it is the only way that PSBs will ever find their way out of the current mess. However, to ensure provisioning can continue, a PSB must have enough depth and cushion, in terms of capital, to be able to take the hit quarter after quarter, and still not go bankrupt. Therefore, when the RBI and the GOI want the banks to provision for these NPAs, they must first ensure that they have enough capital to see the provisioning process through. The problem is, that most PSBs that are worst hit by the NPA situation, are in no shape, from a capitalization point of view, to dive into the provisioning process to write-off the bad loans.

Work cut out for RBI and Government

The RBI, along with the government, has decided to get to work by deliberating on a well-structured and timeline based recapitalization process for the worst hit PSBs. The government has already decided to pump in Rs. 75,000 crore into PSBs over a four-year period that ends in March 2019. The possible routes that the RBI could look at, for recapitalization, maybe in the form of raising capital by the PSBs from the markets, dilution of government holding in the PSBs, or simply additional capital infusion by the government.

More desperate measures may include the sale of assets, especially non-core ones, and strategic mergers, some of which we’ve already seen in the recent past. The lender banks will be provided with enough balance sheet strength to absorb the losses, and the timeline of capital infusion will also be critical, since it must match the planned provisioning, which in turn, must match the outlook of the NPA scenario, going into the future.

Currently, the total Gross NPA ratio of the Indian banks is at 9.6%, and the total percentage of stressed loans is at 12%, which includes the number of restructured loans too (which were restructured in order to keep the loan from becoming a bad loan). PSBs currently have over Rs. 8 lakh crore in NPAs and this number might swell in the future. The Insolvency and Bankruptcy code provides the banks with a structured process to recognize NPAs, take write-offs accordingly, and prepare for the same. The banks will need to book losses or haircuts, in order to complete the provisioning and restructuring process.

This restructuring may work to resolve the current NPA problem, but the larger problem lies in the credit appraisal and credit discipline of the lender banks and the borrower companies, respectively. Credit appraisal refers to a check of the credit worthiness of the borrower by the lender bank. Credit discipline refers to the practices that maximize the willingness and ability to repay debts, by the borrower. Among the most impacted PSBs are IDBI Bank, Indian Overseas Bank, UCO Bank, and Bank of Maharashtra. These banks figure on the top of the list of the 20 banks with most NPAs, a list that has 18 PSBs.

Featured photo source: Wikimedia Commons