India-First-Global-Insights-Analysis -Sharing-PlatformIndia-First-Global-Insights-Analysis -Sharing-Platform

Severity of bad loan problem: NPA’s in India’s Banking Sector

and , October 9, 2017, 0 Comments

India’s ratio of non-performing loans (NPA) to the gross loans has shown a steep rise in the last 5 years, hovering over 9% as of 2016. When compared to other developing economies, the present condition of Indian banking sector shows a dismal state. China, Brazil and South Africa are all below the 4% mark which is considered as a safe zone.

In this article analysis, we try to give a snapshot of the ballooning bad loan problem (NPA) in Indian Banking Industry along with few policy suggestions for building a stable roadmap for this Industry.

The worst is certainly not behind for the Indian banking industry and the latest RBI data accentuates the point. According to the Reserve Bank of India’s (RBI) June Financial Stability Report, the risks to the banking industry’s stability have worsened. It warns that the banking system’s gross bad loan ratio will rise to 10.2% of the total loan book in March 2018 from 9.6% in March 2017. The ratio may even jump to 11.2%. For public sector banks, the gross NPA could be as much as 14.2% by March 2018, from 11.4%.

The profitability of the banks would be hit and capital would be eroded by deteriorating asset quality, thereby curbing their ability to give loans to the borrowers. The report points out that the capital adequacy ratio—or capital as a percentage of a bank’s risk-weighted loan exposures —of six banks is likely to fall below 9% in a severe macro stress scenario, pulling down the industry’s capital adequacy ratio from 13.3% in March 2017 to 11.2% in March 2018

Definition of NPA in Banking Sector

As per the master circular of RBI, an asset becomes non-performing when it ceases to generate income for the bank. Earlier an asset was considered as non-performing asset (NPA) based on the concept of ‘Past Due’. A ‘Non Performing Asset’ (NPA) was defined as credit in respect of which interest and / or installment of principal has remained ‘past due’ for a specific period of time (Specified period being 2 quarters in 1995). An amount is considered as past due, when it remains outstanding for 30 days beyond the due date. However, with effect from March 31, 2001 the ‘past due’ concept has been dispensed with and the period is reckoned from the due date of payment.

With a view to move with the best international practices and to ensure greater transparency, with effect from March 31, 2004, a non-performing asset shall be a loan or an advance where:

Interest and / or installment of principal remain overdue for a period of more than 90 days in respect of a Term Loan.

The account remains ‘Out of order’ for a period of more than 90 days, in respect of an Overdraft / Cash Credit (OD/CC).

The bill remains overdue for a period of more than 90 days in the case of bills purchased and discounted,

In the case of direct agricultural advances the loans would be treated as NPA considering the duration of the crop season. In respect of agricultural loans more than 2 crores, identification of NPAs would be done on the same basis as non-agricultural advances.

Any amount to be received remains overdue for a period of more than 90 days in respect of other accounts.

Based upon the period to which a loan has remained as NPA, it is classified into 3 types Substandard Assets – An asset which remains as NPAs for less than or equal to 12 months, Doubtful Assets – An asset which remained in the above category for 12 months and Loss Assets – Asset where loss has been identified by the bank or the RBI, however, there may be some value remaining in it. Therefore loan has not been not completely written off.

Factors contributing to NPA formation

Usually the banks have a conservative credit policy which has many filters such as previous credit profile, if the loan seeker has defaulted in the past, his cash flow, i.e. if his future income is stable and reliable, if it is a secured loan, then if the property/asset on which loan is sought, has sufficient value so that banks can liquidate it if necessary and many such filters. Yet, despite this diligence, banks do have NPAs. However the question is why have the public sector banks having such abnormally high NPA?

There are 2 groups of defaulters who have majorly contributed to this. The First group are big companies and corporate houses. Public Banks, possibly under political and economic pressure gave loans to a lot of companies who defaulted and the second group is that of farmers. Since 2012, despite a lot of farm loan waiver schemes, the agricultural sector has led to high NPAs. An internal study conducted by RBI lists out the following factors contributing to the NPA formation in banking sector of India:npa-formation-india-marketexpress-in

Metrics to Asses NPAs

Traditionally, two metrics are used to assess the scale of the problem

  • The ratio of NPAs (gross or net) to gross domestic product (GDP) – measures the potential losses in relation to the size of the economy and is helpful in comparing different countries. However, this measure does not indicate about banks ability to handle the NPAs with their own capital.
  • The ratio of NPAs to total loans – shows the fraction of bank loans that has turned bad. One shortcoming of this measure is that it suggests the problem can be solved through denominator management—growing the loan books of banks to make the NPA ratio smaller assuming that the source of the NPA problem is external to the banking system and not in the weaknesses of the lending processes. Moreover, it is difficult for the NPA-ridden banks to grow. Prolonged NPA episodes erode banks’ capital and constrain their ability to grow their loan books.

The ratio of non-performing loans to the gross loans has risen by 350% in the last 5 years, a very steep rise indeed. When compared to other developing economies, the present condition of Indian banking sector shows a dismal state. China, Brazil and South Africa are all below the 4% mark which is considered as a safe zone. India’s however, is hovering over 9% as of 2016 which has increased since then. This official figure is the best case scenario, the ground reality being even worse.npa-loans-gross-loans-india-marketexpress-in

NPAs in Major Indian Banks – June’17

The end of June quarter 2017 saw the total bad loans of India’s 38 listed commercial banks crossing Re 8 lakh crore, roughly 11% of the total loans given by the banking industry. The public sector banks comprise about 70% of the total book, however 90% of the bad loans are present in their balance sheet. These numbers leave out the loans which are being structured and are technically retained as standard in the book of banks.

SBI’s combine gross NPAs surged by 150 percent or Re 1.13 lakh crore to Re 1.88 lakh crore in the June quarter from Re 75,068 crore in September 2015. PNB comes second in the list with Re 57,721 crore gross NPAs, followed by BOI (Re 51,019 crore). ICICI Bank with Re 43,148 crore gross NPAs tops the private sector list. Its bad loans soared by 172 percent or Re 27,290 crore in the past 7 quarters from Re 15,858 crore in September 2015 to Re 43,148 crore in June 2017. Axis Bank stood at second position with Re 22,031 crore bad loans. HDFC Bank was the distant third with Re 7,243 crore of gross NPAs.gross-npa-private-banks-psb-india-marketexpress-in

The gross NPA values do not give us the full picture as the loan book of banks are different and what matters is the NPA to total loan ratio.

IDBI Bank with 24.11 percent, tops the list. That means every Rs 24 out of Rs 100 lent by the bank has not come back. Indian Overseas Bank follows with 23.6 percent gross NPAs and UCO Bank with 19.87 percent. Out of 21 state-run banks, 17 lenders recorded over 10 percent gross NPAs as percentage of their advances as of 30 June 2017. Another two had gross NPAs close to 10 percent each, while eight PSBs have gross NPAs of over 15 percent.

Among 17 private banks, Jammu & Kashmir Bank tops the bad loan table with gross NPAs of 10.79 percent of its total advances as of 30 June 2017. ICICI Bank figures second on the list with 7.99 percent bad loans and Kerala-based Dhanalaxmi Bank follows next recording 5.62 percent of its loans as bad in the June quarter.Public-Banks-Private-Banks-india-marketexpress-in

What’s the way forward?

The central Govt. of India along with RBI has to take urgent step to tackle the menace of mounting bad loans, which is denting profits of lenders, slowing the credit flow to industry and hurting the economy –

Accelerating recoveries from NPAsThe traditional way to tackle this problem via restructuring won’t help as there is a “solvency problem” and not a “liquidity problem. The scheme to convert debt into equity through strategic debt restructuring scheme started by RBI didn’t work as there were problems of coordination among the different banks involved, regulatory uncertainties (especially for infrastructure projects) which deter new investors, and the unwillingness of bankers to accept a sufficient write-down the outstanding debt. The best solution is to create a new Government  Institution called the “Bad Banks” which will handle the recovery of the bad assets transferred by the public sector banks. This new entity could be funded by Govt. bonds, which could be exchanged for the NPAs offloaded from banks. This solution has some obvious advantages:

  • This new entity can offer a realistic level of debt reduction
  • Much less vulnerable to charges of corruption if the urgency involved in clearing out NPAs is clearly written in its mandate.
  • Bankers would be willing to transfer their assets to a public sector entity than to a private entity.
  • An additional high-level oversight board could vet the proposals.
  • Could work either by retaining the present management or changing the management on a case to case basis.
  • Form a partnership with private entities to bring in expertise or additional investor.

Recapitalizing of Public Sector BanksThe traditional way of distributing budgetary funds with the weaker banks getting proportionately more funds could be reversed, where stronger banks get more funds incentivizing the weak banks to perform better. The Govt. Equity could be made below 51% in order allow some of the banks raise capital in a more favorable manner while attracting some strategic investor to turn them around. Following the Chinese model, a board seat could be offered to them, although not involving them directly in the day to day management.

Reforms of the banking SectorAmendment to the Banking regulation act under which it can authorize the RBI to issue directions to banks to initiate insolvency resolution process to recover bad loans. As part of its strategy to rein in the unacceptable level of NPAs, Reserve Bank of India recently identified 12 accounts for Insolvency and Bankruptcy Code (IBC) proceedings with each of them having over Rs 5,000 crore of outstanding loans, accounting for 25 per cent of total NPAs of Banks.

The recommendation given by P.J. Nayak committee, of vesting the government’s shareholdings in public sector banks in a separate holding company, and limiting the finance ministry to deal only with the holding company on policy issues could be another way. Stricter rules for joint lenders’ forum (JLF) and oversight committee (OC) to curb NPAs could be another potential solution.