Sowing inclusion, reaping NPAs: Financial Express 1st May 2014

An increase in NPAs is normally attributed to factors such as ownership, management, credit assessment quality, economic downturn, sectoral performance, wilful default or just bad luck. Is it possible to separate the causes that are macro in nature from the banks-specific ones? The accompanying table provides information on the NPA ratios of various banks for FY13 in different sectors based on their annual reports. The focus is on 21 public sector banks, though 5 new private banks have also been included for the purpose of comparison. The PSBs exclude the SBI associate banks as information is not uniformly available for them. It is assumed that the analysis will be the same. Agriculture has highest NPA ratio for 9 of the 21 banks. The second-highest was industry with 6, followed by personal loans and services with 3 each. Four banks had agriculture as the second-largest sector with high NPAs though services led with 10 banks, followed by industry with 6 and personal loans with 3 (adding up to 23, as two had the same level of NPAs in two sectors). What conclusions may be drawn? First, personal loans appear to be a safe avenue for lending as there is rarely a systemic risk which spreads based on non–performance of a sector like agriculture or industry. As it is well spread across individuals and the ability of an individual to service the loan is not linked with that of any general parameter, the linkage is dispersed. However, the extent to which some banks have very high ratios in this segment such as Allahabad Bank, Bank of Baroda and the Oriental Bank of Commerce, there is a need to examine which segment within this sector has not performed so that prompt action can be taken. Normally, this sector has lower delinquencies but there could be a concentration in the home loan segment where high interest rates could have affected the repayment capacity. Second, agriculture is clearly the most vulnerable sector generating NPAs.While it is puzzling as to why there should be a variation in these ratios across banks, it can be partly explained by looking at the areas where these loans are given, which would be crop-specific. However, at a more generalised level, the moral hazard in such loans is there is a propensity not to repay in the hope that these loans would be written off. In fact, even among the private banks considered here, NPAs were highest for Axis Bank, followed by ICICI Bank. Aggressive forays into this segment lead to a tendency to build up NPAs. Farm loans are a touchy issue given the sensitivity involved. It is here that we need to take a call on priority-sector lending. While inclusive banking is okay when banking has socialistic grounds, it becomes a contradiction when banks have to comply with global norms of capital adequacy and quality of assets besides being answerable to shareholders. Ideally, banks should not be forced to lend to specific sectors. But if it has to be done, then the bad assets which arise on account of, say, crop failures, should be financed through Central and state budgets. There are no easy ways to figure out what part of the NPA is due to error in judgment and what is due to climate failure. But the banks’ bearing the NPA burden in such sectors may not be a good idea, especially as it impinges on the quality of the financial system. The issue is tricky because banks are reluctant to admit that farm loans are a drag on their balance sheets as it is politically correct to say that these loans are profitable. At a broader level, RBI needs to find ways to scale down this commitment for the banks, with the government pitching in to fill the gap. We need to strike a balance here and not go overboard on inclusive lending. New entrants into this arena should keep this in mind as they would be especially vulnerable. Third, NPAs in industry are also high which can be linked to a great extent with the state of the economy and the virtual standstill of several infrastructure projects or those related to government spending where there are defaults. Also, the slowdown in consumption across the board has affected corporate profitability, something that is reflected here. As interest rates have tended to be high this year, affecting the SME segment more than the others, this could be sector-specific. However, it must also be noted that these numbers are lower in relative terms partly due to the restructuring of many such loans, pushing them out of the NPA book. The numbers would have been more prodigious in case they were included. Lastly, service sector loans also have been high for banks and they need to revisit their genesis as NBFCs, commercial real estate and trade are the dominant components here. This should be a worry, especially so since the service sector had been the best-performing sector in the GDP calculations and an increase in bad assets here would tend to reflect more on judgment and could be bank-specific. Quite clearly, while individual banks need to go back to their NPA books and make a comparison with their peers on the sectors that crowd them and the priority-sector lending issue should be reconsidered by RBI, a possible monsoon failure this time round will make these numbers look nastier.