NPA Crisis

[op-ed snap] Resolving India’s banking crisis

Note4Students

From UPSC perspective, the following things are important :

Prelims level : NPA

Mains level : Resolving NPA crisis

CONTEXT

The government that assumes office after the general election will have to crack a serious and unresolved problem: India’s banking sector.

Background

  • 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.

6.Risk management

  • 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.

Conclusion

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.

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