RBI?s bad loan resolution: Indian banks brace for profit cuts in FY18

By Devangi Narang

A sound banking system is the backbone of an emerging economy. The banking sector in India has grown tremendously after Independence, particularly after the globalisation reforms. The Indian banking industry is currently worth Rs. 81 trillion ($1.31 trillion). Given the enormous size of our banking industry, the current Non-Performing Assets (NPAs) crisis is a matter of great concern.

Debt menace and RBI intervention

The gross debt of the banking system as of March’ 17 was Rs. 7.11 lakh crore. This has shown a 135% increase in the bad loan crisis from Rs.261,843 crores in the last two years. According to recent forecasts by ICRA (Investment Information and Credit Rating Agency of India), the GNAPs (Gross Non Performing Assets) of Indian banks are expected to rise to 9.9%- 10.2% by March 2018, from 9.5% in March 2017.

The process of resolving the bad loan problem gained impetus on May 5, when the Indian government notified an ordinance empowering the central bank to coax banks into resolving bad-loan cases. Previously, RBI had no role to play in resolving individual bad-loan cases.

RBI followed it up by forming an internal advisory panel that analysed the top 500 defaulters and winnowed the list down to twelve large ones (that covered 25% of the banking system’s NPAs) that should be hauled to the bankruptcy court first under the Insolvency and Bankruptcy Code 2016 (IBC). This means that these twelve accounts would be responsible for about Rs. 1.78 lakh crore of bad loans. This stress on assets is coming from a few sectors such as power, telecom, steel, textiles and aviation. Top defaulters include Essar Steel, Bhushan Steel, Alok Industries, Monnet Ispat, Jyoti Structures and Electrosteel. Nine out of twelve cases have already been heard at the company law tribunal up til now.

Indian banks to face profit cuts

A major concern for banks are the so-called hair-cuts or sacrifices to be made, and losses suffered during resolution at a time when they are starved of capital. Provisioning norms require banks to set aside a portion of their earnings on the assumption that the entire amount lent will not come back. Accordingly, the central bank has asked banks to set aside 50% provisions for accounts being resolved through the insolvency law. 

Indian Ratings’ data released on July 18 indicates that Indian banks have to set aside provisions of at least Rs.18,000 crore as they approach National Company Law Tribunal (NCLT) to recover bad loans from a dozen large defaulting companies identified by RBI. The move may eat into the profit margins—around 25% in FY18—of banks already grappling with mounting bad loans.

On further analysis, the data also reveals that the banks would have to face a decrease in return on assets by twelve basis points (0.12%) in FY18. Of the total Rs. 18,000 crore required for provisioning, the iron and steel sector contributes about Rs.10,500 crore and infrastructure Rs. 4,100 crore.

According to data by Crisil, lenders may have to forget 60% of their outstanding dues or about Rs 2.4 lakh crore from top 50 stressed companies that could not repay their loans leading to insolvency battles. Out of this, construction sector holds one-fourth share of total bad loans. While the metal sector forms the highest share of sticky loans at 30%, the power sector is at 15%. The rest is segregated among other companies. While banks may have already provisioned for a part of these exposures, Crisil’s analysis indicates that an incremental provisioning of about 20% may be required.  

Improving financial health of banks

Emboldened by the Banking Regulation (Amendment) Ordinance, RBI is expected to push for the resolution of these bad loans by March 2019, according to an ASSOCHAM (The Associated Chambers of Commerce of India) study. This is good news considering the fact that it takes four years on an average to resolve a bad loan case in India compared to ten months in Singapore and one year in the UK (2014 World Bank report).

This move could bring down the NPA menace and improve the financial health of banks at the earliest possible. A close analysis also shows that the problem is multifaceted and need to be dealt at multiple levels. Right steps, along with timely and concerted actions will be required to put a permanent lid on these stressed assets.

Featured Image Source: Flickr