According to the Reserve Bank of India an “asset, including a leased asset, becomes non performing when it ceases to generate income for the bank.” Generally speaking, NPAs are those loans in the books of financial institutions that have been defaulted upon or are in arrears on the day of payment of either the interest or the capital at the time of maturity. Assets are designated as such after a standard time period of 90 days. Banks have conventionally dealt with NPAs by i) restructuring them, ii) taking ownership of the collaterals, iii) converting bad loans into equity (aiming at appreciation) and iv) selling these loans to specialized loan collection companies. Loans could be said to have gradual progressions starting from them first being standard assets to substandard assets, then doubtful assets and finally losses that cannot be hoped to be recovered at all. Ideally, banks are supposed to make provisions to deal with these non performers. However, this has not been followed and the result has been a burgeoning NPA – a staggering 7.6% of the total loans advanced as on March, 2016 (as per RBI). Public sector banks lead the foray accounting for approximately 90% of gross NPAs in the country.
This was obviously not an overnight event and its start could, in fact, be linked back to the period from 2000-2008 where loans were given indiscriminately during the boom period. With 2008 came the recessions and with it the profits of the companies evaporated contributing to their inability to pay back the debts they had undertaken. The situation was made worse due to the fact that there had been no proper background checking about the creditworthiness and financial standing of the borrowers. Recession had caused a meltdown in the global demand as well and the funds could not be recovered even through exports. Infrastructure projects were stalled and the borrowers were stuck with high costs and the inability to repay them. Borrowers remained as ambitious as ever, acquiring loans for unfeasible projects which too banks granted. It has been reported that sometimes the banks granted loans without conducting their own investigations. Focus of banks remained on volume and not quality.
Most interestingly, a lot of this problem stems from favourable treatment to certain groups of people. Let us take the case of United Breweries group which has been branded a wilful defaulter. Wilful defaulters are those that have the capacity to repay the loans but illegally do not, or siphon off funds to prevent repayment. As of February, 2016 wilful defaulters owed the State owned banks Rs. 64,335 crores; the United Breweries group owes public sector banks approximately Rs. 6,900 crores (excluding the penalties). The government owns a majority share in the public sector banks and thus it can be correctly guessed that mobilization of such large amounts of sums could not have been undertaken by the PSUs without the express knowledge of the government.
Infrastructure is another field that requires our attention in terms of lending by banks. Lending in the infrastructure and metals sector account for over half the bad debts in the economy. The nature of infrastructure lending is different from other kinds of lending. Infra projects are highly risky with a long maturity period which contrasts with the structure of loans usually provided by banks for their own sustenance. Promoters of infra projects start off with debt funding and then shift to equity sources when the returns are nearer and the risk is lower. But when such projects face delay in completion, the equity option cannot be availed and the interest costs by then have run very high.
The clearest impact of this increase in the NPAs has been felt in rise of the bank interest rates. With a rise in the NPAs, the banks have to make additional provisions for them or write them off which leaves lesser funds to provide loans. When both paucity of funds and high interest rates are coupled, it spells doom for the common man. Not only that, there has been an impact on the stock markets as well with speculators losing confidence and dumping banking shares. Another fall-out has been a visible drop in investment. Public sector banks that are already burdened with past bad debt have shown a tendency to reduce their exposure to industries and infrastructure.
During the regime of Raghuram Rajan as the governor, changes were evident. In 2015-16, an Asset Quality Review (AQR) was conducted by the Reserve Bank of India. The AQR was a thorough and stringent checking of the bank balance sheets and almost all large accounts were inspected instead of the small samples that were usually taken for such inspections. The banks had a tendency to give a misleading picture through restructuring. The AQR enabled the immediate recognition of NPAs and the banks couldn’t escape any longer. Bad loans jumped that fiscal year by 80%. Raghuram Rajan believed that ‘band-aids’ would no longer work, ‘surgery’ was inevitable and recognition of NPAs was just the ‘anesthetic’. The Insolvency and Bankruptcy Bill was introduced that cut down the time required to dissolve an insolvent company from 4 years to 180 days failing which the assets of the company could be sold to repay the creditors.
The Central Bank also facilitated the formation of a Central Repository on Information on Large Credits (CRILIC) that contained information about the status of all loans above the amount of 5 crores that was to be shared by all banks. Further, a Joint Lenders Forum (JLF) was organized to make quick decisions and undertake speedy actions. The JLF could partake of the new Strategic Debt Restructuring scheme wherein they could convert a part of their loans into equity and the consortium would own at least a 51% stake in the defaulting companies. This gave lenders the power to make the companies more viable by making them the owners. The consortium would manage the company for a period of 18 months after which they would be sold to promoters. If they were unable to find interested buyers, the company would be treated as an NPA again.
For bigger stressed accounts, the Scheme for the Sustainable Structuring of Stressed Assets was introduced that aimed to ascertain the sustainable debt that could be repaid. The total outstanding debt would be converted to sustainable debt and equity and would be structured so as to benefit lenders when the situation of the borrower improves. As stated before, infrastructure projects were not typically suited to bank loans because the expected cash flows are after a period of 10-15 years at least for these kinds of projects. Hence, the 5:25 scheme was also implemented that allowed banks to give long-term loans of upto 20-25 years with an option of refinancing every 5-7 years.
RBI as also stressed upon the need for Asset Reconstruction Companies (ARCs) that would specialize in collecting debt. The discount at which the banks sell their bad loans to these companies would be the extent to which they face their losses. As of last month, RBI had already granted licenses to three ARCs.
Even the finance minister recognized the unacceptable levels of NPAs and the credit availability problems it brought with it. The Indradhanush Initiative was also launched that will ensure that the administration and governance of public sector banks remain healthy. The government has agreed to provide a capital infusion of Rs. 70,000 crores for recapitalization purposes but it is to be seen if this amount seems sufficient.
The RBI has issued a tentative deadline of March 2017 for the banks to clear up their balance sheets and make greater provisioning for the NPAs. Seeing this in actual practice will mean the banks will have to be more alert and stringent while doling out loans. Care should be also taken to correctly identify accounts that could be recoverable and further fund only them for guaranteed returns. Amendments have been proposed in the already existing Securitization and Reconstruction of Financial Assets and Enforcement of Security Interest Act, 2002 and the Recovery of Debts due to Banks and Financial Institutions Act, 1993 (which led to the establishment of Debt Recovery Tribunals) for faster recovery. Public sector banks should be given greater autonomy to prevent interference by influential people. It also might be the time to accept that privatization of banks is a necessity. Another long term measure could include speedy recovery of dues to stem the cases of willful defaulting and the erosion of loan values. Banks should also have clear contingency plans to prevent a repeat performance as it will be really tough to survive another period like this.
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