The Banking Sector is the life blood to a free market driven economic order that India aspires to be. The health of the Banking sector as also their commitment to economic growth and progress is vital to the well being of the real sector.
The real sector is where wealth is created, be it Agriculture, Manufacturing or services. The Banking sector is expected to support them in their endeavors. In so doing bankers have the crucial responsibility to asses and monitor risks. In the real sector risks can manifest due to externalities or internal causes.
Root Cause of NPA: Lenient Credit Policy
The sheer magnitude of the NPAs that the Indian Banking sector is now straddled with is a clear indication that the Banks, including and especially the RBI and auditors, have not been doing their job and for a long time.
What is odd about these NPAs is that most loans originated at a specific period between mid-2000s and early 2010s. These were the Go-Go years when reckless lending was a global phenomenon which was arrested only after the 2008 global financial meltdown. Government policy no doubt contributed but banks compromising fundamentals like, adequacy of collateral, when handling credit is hard to explain.
But yes, such things do happen. One such occasion was inspired by the Bush administration policy declaration that every American deserves a house of his own. The consequent relaxation of lending norms resulted in a frenzy of dubious loans.
The risks associated with such loans were widely distributed globally with some highly innovative financial instruments. All this eventually lead to the subprime mortgage crisis with a global financial footprint. The Indian NPAs are miniscule in comparison to subprime mortgage lending and the example is being sited only in the context of manageability of the NPA problem.
Scale of the NPA Problem
Nearer home, as of December 2017 the gross NPA stood at Rs 8.4 Lakh Crores and is roughly a fifth of all loans given by Banks. By banking standards, a loan becomes non-performing when the beneficiary fails to pay even the interest due, over three consecutive quarters.
Genuine external distress as in the steel industry, where China is dumping cheap steel in the Global Markets, may force companies in to such situations. Sector specific down swings are not uncommon in the market place.
The erosion of margins in real estate lead to a number of these companies defaulting. But such defaults need to be rectified in reasonable time, failing which the interest component tends to accumulate to a point where it becomes completely unviable both for the borrower and lender.
This is the case of a significant part of the current NPAs. Not all NPAs are defaults a la Nirav Modi class. The beneficiaries in the NPA list include some of the top business houses in the country. And these are not going anywhere.
Financial distress is integral to free market economics. The financial sector is expected to support the real sector when this happens,at the least by spreading the cost over time. To that extent certain amount of NPAs are inevitable.
And when collectively, they cross a threshold government is expected to intervene. Government involvement is concerned with both ensuring Capital adequacy of banks as also accountability for defaults. Capital infusion shores the dwindling bank Capital base. Rs 8,000 crores have been infused into the banking system.
The effectiveness of the infusion depends on Prompt Corrective Action. The RBI has set certain trigger points that invoke PCA provisions like freezing further credit and to take corrective action on Banks. These measures are to ensure that the banks do not slide further into a debt trap and recover over time. The adequacy of capital infusion depends on how PCA plays out.
Reviving the Credit Cycle
The real challenge for the Banks is the revival of the Credit cycle. The NPA numbers will increase due to the mounting interest component. But new entrants to the list will be a cause of concern. PCA will lead to some reduction in NPA numbers. It will work with Companies with sound credentials but will lead some companies to the newly enacted Bankruptcy Act. NPAs are like a festering wound on the economy hidden away for too long. The Government initiative to address the NPA issue is a positive and will lead to credit growth over time.
Is the worst Over?
As things stand the defaulters have been identified. PCA has forced Banks to take the matter seriously and not keep postponing the problem. PCA has costs associated with it. Absconders and Bankruptcies impose a cost on Banks threatening their Capital adequacy. Capital infusion seeks to provide some relief to Banks.
The downward spiral of bad loan appears to have been arrested. But the hiccups in the revival path is yet to manifest. The next tranche of Capital infusion will be an indicator. But it appears that the trend has bottomed out.
But will this alone lead to credit growth revival that an ambitious India needs to achieve it’s growth objectives? Bankers have argued that credit and interest rates are not the only cause for a dampened investment cycle.
It is only in sectors like infrastructure where massive Government investment is leading to capital hungry projects. Most other sectors show little appetite for big projects either due to unutilised capacities or lack of opportunities and uncertainties. So, the worst may be over for Banks but there is much to be done especially by Banks. The economy also needs to stand up to make what the Banks are doing worthwhile.