Headline : Resolving India’s banking crisis Editorial 11th May’19 TheHindu
India’s banking sector problem:
Huge increase in Non-performing assets (NPAs):
- Non-performing assets (NPAs) at commercial banks amounted to Rs 10.3 trillion, or 11.2% of advances, in March 2018.
- Public sector banks (PSBs) accounted for Rs 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.
- In comparision, in 2007-08, NPAs totalled Rs 566 billion (a little over half a trillion), or 2.26% of gross advances. The increase in NPAs since then has been staggering.
New government will have to address it:
- The new government that assumes office after the general election will have to crack a serious and unresolved problem: India’s banking sector.
- To do so, it needs clarity on how the problem arose in the first place.
How did NPAs reach such high levels?
Origin of the crisis – Credit boom in two of the years:
- The origin of the NPA crisis 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.
- It was a period in which the world economy as well as the Indian economy were booming.
Huge investments were made:
- 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 believed, as many others did, that India had entered an era of 9% growth.
But several projects stalled:
- Thereafter, many things began to go wrong.
- Due to problems in acquiring land and getting environmental clearances, several projects got stalled, and project costs soared.
Costs of borrowing rose:
- 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.
Banks loans started turning into NPAs:
- This combination of adverse factors made it difficult for companies to service their loans to Indian banks.
Asset Quality Review exposed the level of NPAs:
- Before 2014-15, NPAs were being under-stated, and the true level of NPAs was not known.
- The Reserve Bank of India (RBI) then introduced tougher norms for NPA recognition under an Asset Quality Review.
- NPAs in 2015-16 almost doubled over the previous year as a result of correctly identifying the NPAs over the previous years.
- The cumulative bad decisions of the past were now coming to be more accurately captured.
Banks now had to make higher provisions:
- Higher NPAs mean higher provisions on the part of banks.
- Provisioning is setting aside of money from profits to compensate a probable loss caused on lending a loan.
- Provisions rose to a level where banks, especially PSBs, started making losses.
Now banks had less money to lend:
- High provisioning reduces the bank’s ability to lend by that amount out of their capital.
- Capital from the government was slow in coming and it was barely adequate to meet regulatory norms for minimum capital.
- Without adequate capital, bank credit cannot grow.
- While the gross NPAs grew, advances fell, leading to the ratio of gross NPAs/advances to shoot up to a crisis level.
- Once NPAs happen, it is important to effect to resolve them quickly. Otherwise, the interest on dues causes NPAs to rise relentlessly.
Is the problem mainly to do with the Public Sector Bank Management?
Some suggested privatisation of PSBs:
- Since the problem is more concentrated in PSBs, some have argued that public ownership must be the problem.
- Public ownership of banks is beset with corruption and incompetence (reflected in poor appraisal of credit risk).
- They suggest that the solution, therefore, is to privatise the PSBs, at least the weaker ones.
But this is not so straightforward:
- There are wide variations within each ownership category.
- In 2018, the State Bank of India’s (SBI’s) gross NPA/gross advances ratio was 10.9%.
- This was not much higher than that of the second largest private bank, ICICI Bank, 9.9%. The ratio at a foreign bank, Standard Chartered Bank, 11.7%, was higher than that of SBI.
- Moreover, private and foreign banks were part of consortia that are now exposed to some of the largest NPAs.
Few sectors actually causing most of the NPA problem:
- The explanation lies elsewhere. 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%.
- PSBs have accounted for an estimated 86% of advances in these five sectors.
These sectors affected by various issues not just bank management:
- The infrastructure projects were impacted by the global financial crisis and environmental and land acquisition issues.
- In addition, mining and telecom were impacted by adverse court judgments.
- Steel was impacted by dumping from China.
- Thus, the sectors to which PSBs were heavily exposed were impacted by factors beyond the control of bank management.
Plans to prevent such crises
- Wholesale privatisation of PSBs is thus not the answer to a complex problem.
- We need a broad set of actions, some immediate and others over the medium-term and aimed at preventing the recurrence of such crises.
- Immediate actions:
- Resolving NPAs:
- An 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.
- Panels to oversee resolution:
- The Indian Banks’ Association has set up a six-member panel to oversee resolution plans of lead lenders.
- To expedite resolution, more such panels may be required.
- Loan Resolution Authority could be set up:
- An alternative is to set up a Loan Resolution Authority, if necessary through an Act of Parliament.
- Bank recapitalisation:
- The government must infuse at one go whatever additional capital is needed to recapitalise banks — providing such capital in multiple instalments is not helpful.
- Medium term actions:
- Monitoring macro-prudential indicators:
- Over the medium term, the RBI needs to develop better mechanisms for monitoring macro-prudential indicators.
- It especially needs to look out for credit bubbles.
- Banking governance reform:
- 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.
- Preventing concentration of loan exposure:
- One important lesson from the past decade’s experience with NPAs is that management of concentration risk (that is, excessive exposure to any business group, sector, geography, etc.) is too important to be left entirely to bank boards.
- The RBI has drawn this lesson to some extent.
- Effective April 1, 2019, the limit for exposure to any business group has been reduced from 40% of total capital to 25% of tier I capital (which consists of equity and quasi-equity instruments).
- The limit for a single borrower will be 20% of tier 1 capital (instead of 20% of total capital).
- Risk management:
- Overall risk management at PSBs needs to be taken to a higher level.
- This certainly requires strengthening of PSB boards.
- We need to induct more high-quality professionals on PSB boards and compensate them better.
- Succession planning at PSBs:
- Succession planning at PSBs also needs to improve.
- Despite the constitution of the Banks Board Bureau to advise on selection of top management, the appointment of Managing Directors and Executive Directors continues to be plagued by long delays. This must end.
- 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 with a steely focus on the part of the government.
GS Paper III: Indian Economy
Acceleration in economic growth is not possible without addressing the problem of non-performing assets in the Indian banking sector. Critically discuss.