One of the areas
that Dr Raguram Rajan focused on when he made his first speech as RBI Governor
was quality of assets. He had indicated that RBI would be looking closely at
these numbers and their originators and that there would be little lenience
shown to them. Growing NPAs has been an issue in the last two years with a lot
of camouflage being alleged by some in the form of restructured assets.
While the talk has largely been on corporate loans that have gone bad, it is also necessary to look at the delinquencies in the priority sector. For example, in FY12, around half of the NPAs of public sector banks emanated from this sector, which contributed to less than 30% of outstanding loans of banks. We have also seen that there has been a lot of thrust being put on inclusive banking, meaning thereby that banking has to be taken to the poor so that they have access to the formal system and do not have to go to the moneylenders. To this effect, RBI has linked new bank licences with the opening of 25% branches in non-banked rural areas. The contention here is that while NPA growth is serious, there can be some contradictions with the objective of inclusive banking as the propensity of priority sector loans going bad appears to be higher than that of regular loans.
Priority sector lending has been spoken a lot by banks as it is politically correct to do so. Also, there has been the non-bankable segment that was supported by MFIs, which later became controversial on account of the high rates charged. Using counter-intuitive logic, if the non-bankable was bankable, then banks would have already been there. Given that banks did not lend to this segment, as most lending is collateral based, and this segment does not generally have collateral to offer and also have more granular demand in terms of quantum, this action was deliberate. Now that we are refocusing on this segment through new banks and, at the same time, talking of controlling growth in NPAs, there is need to revisit our logic.
The accompanying table provides information for the ratio of gross NPAs to total outstanding loans for public sector banks for both priority and non-priority sector loans.
The table shows that the levels of NPAs in priority sector are not just higher but multiple times that of non-priority sector. The non-priority sector loans have risen sharply in FY12, which was the first year of economic decline in the country when the proclivity for NPAs to increase became sharper. This was also the time when restructured assets increased, which got exacerbated in FY13. In fact, total debt restructured increased from R1.10 lakh crore in FY11 to R1.50 lakh crore in FY12 and further to R2.29 lakh crore in FY13. Therefore, the numbers in the table rebound to be much bigger in FY13 for non-priority sector loans.
What are the solutions? In case of inclusive loans, there appears to be little that can be done as banks have perforce to lend to risky segments. A way out is that instead of the government keeping aside money for recapitalising public sector banks, they should be asked to raise the same from the market. The allocations set aside for capitalisation can be disbursed to all banks to write-off loans in this segment. This way banks will be incentivised to lend to this segment as the risk will be partly hedged. Such funding from the government’s perspective would be akin to, say, the MGNREGA programme or food subsidy programme. To make it effective this can be made conditional on being more efficient with NPAs on the non-priority loans.
The challenges for non-priority sector loans are many. To begin with, one must separate the wilful defaulters from those who have genuine problems. This is difficult because the structure of Indian corporates is such that promoters’ liability is restricted to their equity stake and hence the enterprise loss is not theirs’. As a result, the promoter with NPAs can still live the good life. One way to check this is that defaulters should be banned from taking further loans. This becomes difficult because if the cause is genuine, then the penalty is too harsh. Often loans to revive the enterprise are the only way out to get the money back in the long run. But knowing this, companies can choose not to perform, knowing well that they have to be bailed out as they cause a systemic risk in the system. This is a major moral hazard in banking.
How do we solve this problem? There is enough knowledge on defaulters provided by credit information bureaus. There is evidently a commercial angle to this story which still makes banks lend money. At one extreme, corporate debt restructuring should not be allowed. But then there are lots of projects that have been held back due to circumstances beyond their control, such as clearances or land acquisition, litigation, etc, and would be penalised. But such genuine causes would be there for almost all non-wilful defaults. The onus should be transferred to banks through an incentive scheme as outlined earlier.
At a different level, we need to have early warning indicators for NPAs, and the best way out is to have all bank loans rated by a credit rating agency (a lot of them are rated already under Basel II implementation for assessing risk-weighted capital). Credit rating agencies have more stringent criteria for rating and any movement in such ratings should send a signal to the banks that the account is not in order. This way banks can take action at an early stage and not wait for the three-month delinquency mark to be breached before such classification.
It should be recognised that the financial system is getting complex where business cycles are bound to affect the economy and the quality of assets of banks. At the same time, there are compulsions to make banks responsible towards social causes, which can be debated but is inescapable. The government should work towards marrying the two, by funding these NPAs and making it contingent on performance in the secular space. It may just work.
While the talk has largely been on corporate loans that have gone bad, it is also necessary to look at the delinquencies in the priority sector. For example, in FY12, around half of the NPAs of public sector banks emanated from this sector, which contributed to less than 30% of outstanding loans of banks. We have also seen that there has been a lot of thrust being put on inclusive banking, meaning thereby that banking has to be taken to the poor so that they have access to the formal system and do not have to go to the moneylenders. To this effect, RBI has linked new bank licences with the opening of 25% branches in non-banked rural areas. The contention here is that while NPA growth is serious, there can be some contradictions with the objective of inclusive banking as the propensity of priority sector loans going bad appears to be higher than that of regular loans.
Priority sector lending has been spoken a lot by banks as it is politically correct to do so. Also, there has been the non-bankable segment that was supported by MFIs, which later became controversial on account of the high rates charged. Using counter-intuitive logic, if the non-bankable was bankable, then banks would have already been there. Given that banks did not lend to this segment, as most lending is collateral based, and this segment does not generally have collateral to offer and also have more granular demand in terms of quantum, this action was deliberate. Now that we are refocusing on this segment through new banks and, at the same time, talking of controlling growth in NPAs, there is need to revisit our logic.
The accompanying table provides information for the ratio of gross NPAs to total outstanding loans for public sector banks for both priority and non-priority sector loans.
The table shows that the levels of NPAs in priority sector are not just higher but multiple times that of non-priority sector. The non-priority sector loans have risen sharply in FY12, which was the first year of economic decline in the country when the proclivity for NPAs to increase became sharper. This was also the time when restructured assets increased, which got exacerbated in FY13. In fact, total debt restructured increased from R1.10 lakh crore in FY11 to R1.50 lakh crore in FY12 and further to R2.29 lakh crore in FY13. Therefore, the numbers in the table rebound to be much bigger in FY13 for non-priority sector loans.
What are the solutions? In case of inclusive loans, there appears to be little that can be done as banks have perforce to lend to risky segments. A way out is that instead of the government keeping aside money for recapitalising public sector banks, they should be asked to raise the same from the market. The allocations set aside for capitalisation can be disbursed to all banks to write-off loans in this segment. This way banks will be incentivised to lend to this segment as the risk will be partly hedged. Such funding from the government’s perspective would be akin to, say, the MGNREGA programme or food subsidy programme. To make it effective this can be made conditional on being more efficient with NPAs on the non-priority loans.
The challenges for non-priority sector loans are many. To begin with, one must separate the wilful defaulters from those who have genuine problems. This is difficult because the structure of Indian corporates is such that promoters’ liability is restricted to their equity stake and hence the enterprise loss is not theirs’. As a result, the promoter with NPAs can still live the good life. One way to check this is that defaulters should be banned from taking further loans. This becomes difficult because if the cause is genuine, then the penalty is too harsh. Often loans to revive the enterprise are the only way out to get the money back in the long run. But knowing this, companies can choose not to perform, knowing well that they have to be bailed out as they cause a systemic risk in the system. This is a major moral hazard in banking.
How do we solve this problem? There is enough knowledge on defaulters provided by credit information bureaus. There is evidently a commercial angle to this story which still makes banks lend money. At one extreme, corporate debt restructuring should not be allowed. But then there are lots of projects that have been held back due to circumstances beyond their control, such as clearances or land acquisition, litigation, etc, and would be penalised. But such genuine causes would be there for almost all non-wilful defaults. The onus should be transferred to banks through an incentive scheme as outlined earlier.
At a different level, we need to have early warning indicators for NPAs, and the best way out is to have all bank loans rated by a credit rating agency (a lot of them are rated already under Basel II implementation for assessing risk-weighted capital). Credit rating agencies have more stringent criteria for rating and any movement in such ratings should send a signal to the banks that the account is not in order. This way banks can take action at an early stage and not wait for the three-month delinquency mark to be breached before such classification.
It should be recognised that the financial system is getting complex where business cycles are bound to affect the economy and the quality of assets of banks. At the same time, there are compulsions to make banks responsible towards social causes, which can be debated but is inescapable. The government should work towards marrying the two, by funding these NPAs and making it contingent on performance in the secular space. It may just work.
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