Surging bank bad debts: What is the way ahead?

Surging bank bad debts: What is the way ahead?

Indian banking industry is hit by the triple whammy of the slowest annual credit growth rate in the last 20 years, large non-performing assets and a volatile bond market. While PSU banks have been hit the hardest, all banks are affected.

Globally, banks are focusing on transforming themselves to leverage the opportunities and cope with challenges thrown up by the powerful forces changing and reshaping the banking industry, viz customer expectations, technological changes and capabilities, demographics and macroeconomic shifts and competition from non-banking players.

However, with lower income growth, increasing provisions for NPAs and possible mark to market losses, our banks have more immediate issues to deal with.

There is a lot of discussion on PSU bank losses since the December quarter results came out. But we all know or ought to know that these banks were sitting on a large portfolio of delayed/stranded projects and credit to highly overleveraged borrowers.

Infrastructure and core sector projects have a long gestation period and repayment schedules start only after a long (2-4 years) construction and commissioning period. So even though we know a large power asset is mostly completed but likely to be stranded for lack of fuel or a road incomplete because of some clearances being delayed, provisioning on these assets usually only begins after the scheduled repayment period starts and if the assets are not restructured. Similarly, debt equity ratios of our corporations have been rising for several years. So what I am saying is that it is not as if banks have suddenly got more NPAs and they have been building up for several years. RBI’s direction on specific assets may have accelerated provisioning requirements but the problem has been building up.

Low credit take off a reason

Another reason for the losses of some banks is low credit offtake. If credit were growing at 18-20% as in the past, income would grow also at the same or similar level as PSU banks do not have many other sources of income that private banks have. In a poor credit growth scenario, NPAs impact earnings twice. First, because of lower interest income due to large NPA and second, because of higher provisioning.

If we are looking for solutions, we will first need to acknowledge that there are no magical solutions.  Further that any solution to resolve NPAs, unless coupled with structural changes in the ownership and management of these banks, can only be an interim solution with every likelihood of the situation repeating itself with investment and credit cycle downturns. Finally, some of this pain is inevitable as we have seen with banks around the world since 2009.

As the Budget is around the corner, let us acknowledge that banks will do well only if there is investment growth and, therefore, credit growth. So the government’s first priority should be to enhance credit growth through measures that can boost investor confidence and increase investment flows. This will include, but not be limited to:

Prudent fiscal management (though perhaps the target of 3.5% fiscal deficit will be hard to achieve if growth is an objective)
Continuing to improve the investment climate including ease of doing business,
Measures to expedite enforcement of contracts
Further structural reforms in some of the key sectors, and
Measures to enable consistency of tax and regulatory actions.
Second, to resolve poor quality assets following steps will need to be taken:
Further policy measures and actions to further unlock stalled infrastructure projects
Judicial reform so that contracts can be enforced, even as the government brings in the the new insolvency and bankruptcy law
Third, banks need further capital. The policy stance has been to go to the market for this capital. Recent financial results will mean an acceleration of the need for capital.

The government may be reluctant to let banks raise the capital in the current market scenario at lower valuations. In this situation, we hope that capital will be forthcoming from the government without increasing the government shareholding. So there is a need to look for ways to capitalise banks without increasing equity capital or alternatively to find ways to separate the bad bank portfolios out with appropriate capital structuring.

Autonomy of boards needed

It is critical that bank credit decisions are taken by autonomous boards. Recruitment of bank executives by independent boards etc suggested by various committees can help in some measure but the real solution is to reduce the government ownership and control of banks. This will be essential both to reduce banks acting as arms of the government or to extend credit for reasons other than sound credit decisions made by the banks, and also to enable bank management and boards to take action with borrowers to recover money as necessary, subject to corporate governance, but without fear of enquiries post facto.

Further, we need company management, boards, banks, the regulator and the ecosystem overall to recognise financial distress early at the project and company level and enable and enforce prompt steps for recovery. RBI has taken a number of steps. Similarly, the new Companies Act puts a lot more onus on company boards.  Are these steps together with the proposed Bankruptcy and Insolvency Law when enacted enough?

The existing framework for insolvency and bankruptcy is entangled with various judicial and quasi–judicial provisos like SARFAESI , DRT, CDR, SDR, BIFR etc. So the implementation of the new Act will require a lot of political and administrative will. Finally, we believe that any of these acts  can be effective only if judicial enforcement can be swift. So judicial reform is essential.

The worst 5 performers (as on Dec, 2015

Loss (Rs Crores)    Gross  NPA (%)    Net NPA (%)
Bank of Baroda    3,342.04    9.68    5.67
IDBI Bank    2,183.68    8.94    4.60
Bank of India    1,505.58    9.18    5.25
UCO Bank    1,497.01    10.98    6.51
Indian Overseas Bank    1,425.06    12.64    8.32
Source: Company Financials           

(The author is the Markets Leader at PwC India)

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