Let me begin today’s column with a famous quote about banking. Even as there are innumerable quotes to share, the kind of bad loan scenario which has plagued the health of banks in the country and further complicated by coronavirus driven lockdowns makes it appropriate to quote James Grant, author of ‘Money of the Mind’. He says: “Growth at an exceptional rate is a red flag in banking. It is hard enough to manage an ordinary bank; to control a sprouting weed is well-nigh impossible. If loans are expanding too quickly, the lending officers have probably been saying ‘yes’ too frequently.”
Today, nothing is fine with the Indian banking industry as the unstoppable piling up of bad loans is proving a termite for the industry; threatening the existence of even so-called strong banks. Before deliberating upon the crisis confronting the banking industry, let’s understand that banks are engine of economic growth since ancient times when it all started from when people were storing their wealth in temples. While tracing the contribution of banks in the health of economy, we find banks since ancient times have played a pivotal role in keeping empires and countries afloat. Even as the finer points of the business model altered with the passage of time, the banks’ basic purpose has remained intact that of protecting depositors’ money and lending those in need of funds for various diverse projects.
The study of economics is on record which reveals that the health of the economy is closely related to the robustness of its banking system. The study has noted that the banking sector has been called upon even at short notice to help countries in times of wars and other crises, including economic crisis to provide requisite resources.
In all circumstance, the banking sector has and will always be the nerve center of the economy as it supports the diverse array of economic activities across the various sectors of the economy. So, it makes a sense for all (government, regulators & citizens) to protect the ability of banks to mobilize resources and channel them to important sector of the economy. The rules and regulations have to be water tight to protect the depositors’ interests and enable banks to retrieve loans from borrowers even those reluctant to repay.
Now coming to the serious health issues confronting the banking industry, let it be clear that deterioration in the asset quality of banks can in no way be attributed to the coronavirus pandemic. Banks have been struggling badly with the burgeoning volume of non-performing loans for the last so many years.
It has been an interesting scenario that since 2012 top management of many banks after every increase in their bad loans were regularly giving statements that the ‘worst is over’. But, what actually happened over the period of all these years is that the situation on account of bad loans only worsened and the Reserve Bank of India’s (RBI) put restrictions on the operations of some major banks by bringing them under preventive corrective action (PCA).
However, the mounting bad loan portfolio of banks refused to scale down despite a series of measures by the RBI to arrest the menace. We can sum up that the regulator simply failed as the banks over a period of witnessed surge in their bad loans portfolio in pre-pandemic period. Actually, the fact is that the RBI missed the actual depth of non-performing assets of the banks when the problem was in its infancy stage.
Precisely, pre-Covid-19 pandemic woes of Indian banking industry will only complicate further in post pandemic situation as loan defaults even in standard category would be rampant and make the NPA basket too heavy. Default in loan repayments after the EMI moratorium expires would continue to remain a major concern threatening the existence of even some major banks, particularly the public sector banks.
Remarkably, CARE, a reputed credit rating agency, in a report has said “the banking sector might witness an adverse impact on credit delivery and asset quality leading to pressure on capital adequacy.” The agency has cited three primary reasons: No substantial improvement in the economy, ageing provisions, and the Covid-19-induced lockdown, which will play havoc with the health of banks.
The worry on account of mounting bad loans has already started unnerving both the RBI and the government. They have started contemplating restructuring of loans and altering prudential norms in accordance with the given situation. Through restructuring banks can modify the loan terms when a borrower is facing difficulties. Relief through a change in the repayment period, repayable sum, number of instalments, rate of interest, rollover of credit facilities, sanction of additional credit facility or enhancement of existing limits is given to the distressed borrower.
Notably, banks and corporates have been seeking an extension of the date of recognition of NPA up to 150 days due to the corporate sector distress. Typically, if a loan is not paid within 90 days, then it is classified as an NPA. Currently, banks have to set aside 0.4% provision in respect of standard assets and 15% provision in respect of sub-standard assets.
According to rating agency Icra, the gross NPAs of banks are likely to worsen to 11.3-11.6% by the end of this financial year from 8.6% as of March 2020, due to disruptions caused by the coronavirus pandemic. Fresh gross slippages are estimated to be at 5-5.5% of standard advances during 2020-21, which will increase banks’ credit provision and impact their earnings.
It’s worth mentioning here, analysts at Macquarie Research pointed out in a research note that at present as much as 20-30% of the loans from banks are under a moratorium. They expect that by the end of August when the moratorium ends, about 50% of the loans from banks could be under a moratorium. Hence, any loan defaults will start only after August but they won’t be immediately categorized as a non-performing asset or a bad loan. Bad loans are largely those loans that have not been repaid for 90 days or more.
Meanwhile, banks are themselves to be blamed for this situation. They haven’t shown interest in cleaning the mess existing in their asset quality. Most of them resorted to ever greening and delayed recognition of bad loans. For all these years reports indicated hidden mess behind the declared financial results in most of the so-called ‘strong banks’.
We have to understand that NPAs do not happen overnight. Loans are sanctioned after a thorough appraisal of the proposal and credit worthiness of the borrower. More importantly, after the sanction, there is this duty enjoined on the lender to monitor whether the amount is being utilised for the appropriate purpose. Thus, those who approve the project report carelessly and fail to monitor such loans should ideally also be held responsible for the loans turning into NPAs.
We have also observed that certain changes in the policies of the Government have proved the greatest reasons for creation of bad loans. The borrower is lured by the State and Central governments promising him all kinds of facilities such as land, power, infrastructure, raw materials, subsidies etc. But unfortunately many of these promises are often a mirage, contributing a great deal to the birth of NPAs.
We cannot overlook the fact that “A stitch in time saves nine”. A regular and systematic follow-up of loan portfolio will help the banks to keep the borrowing unit on their alertness and guide them to rectify their mistakes. This would also be a helping hand in tiding over their tight times. Normally, such close follow-up programs are conspicuous by their absence. In the result, the borrowing units ignore payment of their dues to the banks.
(The views are of the author & not the institution he works for)