The NPA issue has wider implications than its resolution because there is an uncomfortable thought that the high growth rates that were achieved during the earlier part of this decade had compromised credit standards. That is how all bubbles form and erupt. Business cycles are a norm with their amplitude being shorter in this globalised world and phrases like the ‘great moderation’ —which typified the US growth story— no longer can be taken to be a given. There are lessons to be learnt.
First, when there are phases of high growth in credit, which is commensurate with GDP growth, there could be the germination of such problems. Till around FY11, annual growth in credit averaged above 20% for the quinquennium and the NPA ratio was in the region of 2.3-2.5%. This phase was also associated with higher GDP growth and stimulus through fiscal incentives and lower interest rates. Further, the investment rate had reached the level of 35% at a time when infra was in focus.
Quite clearly, banks were extravagant with their standards of lending as it was assumed that good times were there to stay and the growth trajectory would cross 10% per annum. Hence, fast growth in business in any segment should raise the red flag. The second cog in the wheel came about in the subsequent period when growth slowed down as there were several irregularities in policies in mining, telecom, power, which led to a jump in NPAs. However, rather than recognise them as NPAs, the approach was to create a new category of restructured assets which had differential treatment in accounting.
This was a major flaw where standards were compromised to show a better picture. It was something like lowering pass mark in the civil services exams to enable more candidates to pass. Now, the NPAs got camouflaged even while the number rose to 4.5% by March 2015.
The disruption was the asset quality recognition syndrome in August 2015 which magnified the level of impaired assets and affected the credibility of the system. Analogies were drawn to the phenomenon of crony capitalism in East Asia where the financial system financed exponential growth in the nineties. Such growth models are clearly not sustainable. The third part is the resolution aspect where several attempts have been made over the years with the major hitch being the decision on how to get the assets off the books.
This is a practical challenge as taking haircuts on sale of assets is dicey. Further, one is not sure of which assets should be offloaded. This is where the recent legislation empowering the RBI to provide direction is helpful. Will it work? It should be more effective than the earlier measures as it plugs one loophole though the quantum involved is unknown.
Should the RBI be monitoring commercial decisions taken by banks? Logically, it should as it is now getting involved with the resolution of such decisions when assets turn sour. A thought can be that the RBI should periodically announce the vulnerable sectors and warn banks on excess exposures.
Alternatively, the exposure norms for sectors should be capped to ensure less concentration. But such an approach runs the risk of some industries being starved for funds as the market would not welcome those who have no access to bank finance. Another option would be for the RBI to pick up signals when there is high growth in credit- teaser loans are potentially dangerous. There will always be a clamour for low interest rates by banks which can lead to injudicious lending in a bid to meet business targets and enhance shareholder value.
A way out could be that there are fixed guidelines under which an NPA should be disposed of in a pre-decided manner. Based on certain per-specified financial indicators of the defaulters, the haircuts to be invoked can be programmed so that the terms are laid down objectively, leaving less room for discretion. Simultaneously, there would be need to create structures for absorption of such assets either through a bad bank or the legal processes for dissolution. And the last, banks which have a certain threshold level of NPAs could be subjected to rules on payment of dividend, growth in business (narrow banking) and management rewards until such issues are sorted out. A tough call, but considering that deposit holders’ money is at stake, any relief should be made conditional.
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