Stressing that cleaner balancesheets will lead to future loan growth for banks, RBI chief Raghuram Rajan said a "deep surgery" is must for the clean-up that would require an "anaesthetic" in the form of recognising NPAs on their books.
Seeking to soothe the nerves of the banks hit hard by the RBI's diktat to clean up their books by March 2017, the Reserve Bank Governor also said there won't be a repeat of the asset quality review (AQR) that has hit the banks' bottomlines -- which incidentally has resulted in a steep stock fall and a huge erosion of investors' wealth.
Using a medical jargon to impress upon the need for such a review, Rajan said a "deep surgery" is needed to clean up and the process of recognising the NPA is akin to an "anaesthetic" needed for the procedure.
Acknowledging that the AQR, under which the RBI has asked banks to recognise some top defaulting accounts as non-performing ones and provide for them, has had a debilitating impact on banks' numbers and their stocks, Rajan admitted that the earnings of state-run banks do not look "pretty".
While the Sensex has lost a little over 6 per cent since mid-January 15 when banks started declaring Q3 numbers, the sectoral BSE Bankex plunged close to 8 per cent during the same period.
If the fall continues, the market capitalisation of mid-sized private sector bank Kotak Mahindra will be soon be higher than that of the largest public sector bank SBI. Kotak Mahindra Bank today closed the day with a market cap of Rs 115,296.24 crore, while that of SBI was Rs 117,375.5 crore.
The RBI embarked on the AQR exercise from last April and while it had concerns on the world economy, it did not know of the markets getting into turmoil as they have now, he said, defending the move to undertake the AQR.
"We knew at that time that the global economy would continue to be weak but not that markets would be in turmoil as of today. Nevertheless, this simply reinforces our belief that we needed to act when we have to," Rajan said.
Almost all the major lenders in the system have reported a sharp increase in asset quality stress and heightened provisioning as a result of the AQR, under which banks have been reportedly asked to recognise stressed accounts by March end.
Critics say this will result in deserving sections of the economy being deprived of the much needed credit in a situation like the current one filled with economic gloom.
"While the profitability of some banks may be impaired in the short-run, the system, once cleaned, will be able to support economic growth in a sustainable and profitable way," Rajan added.
Invoking the mantra which he gave as an academic while dealing with NPA stress, Rajan said, "To the question of what comes first, clean up or growth, I think the answer is unambiguously 'Clean up'."
In support of the efficacy of his argument, he cited the divergence in sectoral credit growths of the state-run lenders having a larger stressed accounts and the private sector ones with cleaner balance sheets.
Comparing the non-food credit growth, agri-lending and industrial lending, Rajan said, "Loan growth in private sector banks was at least 10 percentage points higher than public sector banks."
Reiterating the target spelled out earlier, Rajan said, "Our intent is to have clean and fully provisioned bank balancesheets by March 2017" and the regulatory forbearance will only postpone the "day of reckoning".
To people who are demanding strong action for bad loans, Rajan said all the NPAs are not caused by malfeasance while asking for action under law to be taken in cases where there is a bad intent.
He also refused to give a final estimate about the extent of provisioning which will have to be done and called some estimates by analysts as "wild claims".
Stating that the government is committed to providing extra capital support to lenders, Rajan said there might be a few cases where the capital ratios may fall under the minimum prescribed level in some banks if government support does not come through.
"Our projections are that any breach of minimum core capital requirements by a small minority of public sector banks, in the absence of any recapitalisation, will be small," he added.
The RBI governor also said there is a need to develop the right management strengths and added that internally, the central bank is also working on ways to hire specialised talent from the private sector to address critical issues.
Rajan said there are two ways to fight the problem of NPAs.
While the first involves brushing the real issue under the carpet to protect profits, another is recognising the problem upfront and dealing with it.
"If the bank wants to pretend that everything is all right with the loan, it can only apply band aids - for any more drastic action would require NPA classification," he said.