The government that assumes office after the general election will have to crack a serious and unresolved problem: India’s banking sector.
- Non-performing assets (NPAs) at commercial banks amounted to ₹10.3 trillion, or 11.2% of advances, in March 2018. Public sector banks (PSBs) accounted for ₹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.
Origin of the crisis
1. Credit Boom –
- The answer lies partly in the credit boom of the years 2004-05 to 2008-09. In that period, commercial credit (or what is called ‘non-food credit’) doubled. I
- 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.
2.Problems with projects
- 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.
- 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.
- The year 2014-15 marked a watershed.
- 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.
- NPAs in 2015-16 almost doubled over the previous year as a result. It’s just that the cumulative bad decisions of the past were now coming to be more accurately captured.
Impact of higher NPAs
- 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. 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.
Reason for high NPAs in Public Sector Banks
- PSBs had a higher exposure to the five most affected sectors — mining, iron and steel, textiles, infrastructure and aviation.
- These sectors accounted for 29% of advances and 53% of stressed advances at PSBs in December 2014.
- For private sector banks, the comparable figures were 13.9% and 34.1%. Our rough calculations show that PSBs accounted for 86% of advances in these five sectors.
Plans to prevent such crises
1. Resolve NPAs –
- 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.
2. Loan Resolution Authority – An alternative is to set up a Loan Resolution Authority, if necessary through an Act of Parliament.
3. Recapitalising Banks – 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.
4. Monitoring macro-prudential indicators –Over the medium term, the RBI needs to develop better mechanisms for monitoring macro-prudential indicators.
5.Governance strengthening at PSBs – 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.
- Other aspects of concentration risk remain to be addressed. We need to induct more high-quality professionals on PSB boards and compensate them better.
- Succession planning at PSBs also needs to improve.
The task of accelerating economic growth is urgent. This is not possible without finding a solution to the problems that confront the banking system. 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.