x Abu Dhabi, UAEFriday 21 July 2017

Diagnosis and cure for India’s sick banks

Public sector bad loans are impairing the overall economy. The RBI governor Raghuram Rajam is tackling the problem – aiming for ‘clean and fully provisioned bank balance sheets’ within a year.

Raghuram Rajam, the Reserve Bank of India governor, says it was not enough to ‘apply band-aids to keep loans current’. Danish Siddiqui / Reuters
Raghuram Rajam, the Reserve Bank of India governor, says it was not enough to ‘apply band-aids to keep loans current’. Danish Siddiqui / Reuters

Mumbai // India’s banks are struggling under the pressure of bad loans, and the problem is set to worsen.

The Reserve Bank of India (RBI) has ordered banks to clean up their balance sheets, resulting in bad debts surfacing that have mounted because of stress in sectors including infrastructure.

Banks’ shares have fallen sharply in recent months. Because of the RBI’s efforts, many lenders reported losses for the latest quarter. These included Bank of Baroda, which posted the largest quarterly loss ever for an Indian bank at 33 billion rupees (Dh1.82bn). IDBI and Central Bank of India were also among those that reported losses. Public sector lenders are carrying far more bad debt than private banks.

Raghuram Rajam, the RBI governor, last month said he had set a target of having “clean and fully provisioned bank balance sheets” by March next year, after it started its asset quality review last year.

Crisil, which is part of Standard & Poor’s, this month downgraded ratings on the debt instruments of eight public sector banks and changed its outlook on five others to negative from stable because of a “steep rise in NPAs [non-performing assets], expected further surge in stressed assets and the consequent hit on profitability and capital”. Crisil expects “the asset quality problems being faced by public sector banks will remain acute and continue through most of the next fiscal”.

Weak assets of public sector banks are expected to soar to 7.1 trillion rupees by March 31 next year, or 11.3 per cent of their total loan book, compared to 4 trillion rupees on March 31 last year, or 7.2 per cent of their loan book, according to Crisil.

“Over the next few quarters, he ratings agency expects slip­pages to NPAs to remain high, driven by stretched cash flows of highly leveraged corporates, mainly in the vulnerable sectors such as infrastructure, metals and real estate, continued proactive recognition of stressed assets by banks, and limited ability of banks in the current environment to recover from exposures to large corporates that have slipped into NPAs.”

It adds that “the earnings profile of most public sector banks has deteriorated with many expected to report a full-year net loss this fiscal”.

The issue of bad loans has come into sharp focus because of the Indian tycoon Vijay Mallya, who has left the country, leaving behind debts of more than US$1bn. Banks including State Bank of India have been closing in to try to recover it following the collapse of his carrier, Kingfisher Airlines, in 2012.

“India is going through a pain point on most of the sectors,” says Rajesh Narain Gupta, the managing partner at SNG & Partners, a law firm. “It may be steel, real estate, infrastructure – all sectors are in stress and the NPA of all the banks – including some of the private banks and foreign banks are all-time high.”

A recent survey conducted by the Federation of Indian Chambers of Commerce and Industry (Ficci) and the Indian Banks’ Association (IBA) of 17 banks in India, including foreign, private, and public lenders, revealed a rise in NPAs and stressed assets during the period between July and December last year.

Seventy-six per cent of respondent banks reported a rise in the level of their NPAs compared to 63 per cent in the previous edition of the survey, which covered the six months between January and June.

“A majority 53 per cent of the respondent banks have also indicated that there has been a rise in the number of cases requesting for restructuring of advances,” according to Ficci. “As per the survey, the key sectors that have seen a surge in NPA levels in the second half of 2015 include infrastructure, metals, textiles, and chemicals, among others.”

Speaking at a banking conference in Mumbai last month, Mr Rajan explained the rationale behind the RBI’s asset quality review.

“Over time, as you know, a number of large projects in the economy have run into difficulty,” he said “Reasons … include poor project evaluation, extensive project delays, poor monitoring and cost overruns, and the effects of global overcapacity on prices and imports. Loans to these projects have become stressed.”

He said it was not enough to “apply band-aids to keep the loan current, and hope that time and growth will set the project back on track”.

Because “most of the time, the low growth that precipitated the stress persists. The fresh lending intended to keep the original loan current grows. Facing large and potentially unpayable debt, the promoter loses interest, does little to fix existing problems, and the project goes into further losses”.

Instead, “deep surgery” which included restructuring and writing down loans was required, Mr Rajan said.

“The bank has to recognise it has a problem – classify the asset as a non-performing asset. Think therefore of the NPA classification as an anaesthetic that allows the bank to perform extensive necessary surgery to set the project back on its feet. If the bank wants to pretend that everything is all right with the loan, it can only apply band-aids – for any more drastic action would require NPA classification.

“If loans are written down, the promoter brings in more equity, and other stakeholders like the local government chip in, the project may have a strong chance of revival, and the promoter will be incentivised to try his utmost to put it back on track.”

Indian banks’ non-performing loans jumped by an “unprecedented” 30 per cent in the third quarter of the financial year because of the RBI audit, according to a Credit Suisse research note.

The bank says that “full recognition of stressed loans [is] yet to happen”.

“Divergence in performance between private corporate and retail lenders increased further as private corporate lenders (ICICI, Axis) also saw a rise in impairments,” Credit Suisse wrote. “Retail lenders continue to report strong growth (25 per cent year-on-year) and are gaining market share at the expense of corporate lenders.”

It expects most of the state banks to recognise more problem loans in the last quarter of the financial year which ends this month.

Jimeet Modi, the chief executive of Samco Securities, a Mumbai-based brokerage, says that “the impact is huge in terms of hampering the growth in the economy” when it comes to bad loans.

He blames a past “lack of ac­count­ability in the government in managing the public sector banks” for the massive burden of bad debt.

“On one hand the public sector banks are flushed with the low-cost funds from the savers on account of deep faith on the government backed institutions and on the other hand the riskiness in their lending practices ... led to good projects at times being rejected and bad ones being funded, creating a lot of stress in the system.”

Mr Modi adds that effective steps are being taken by the government now, including an infusion of funds for state banks being announced in the recently unveiled union budget and plans to introduce a bankruptcy law.

“We hope India will emerge out of the bad loan crises sooner than people expect,” he says.

The authorities are confident that the problem can be managed.

“The clean-up will get done, and Indian banks will be restored to health,” says Mr Rajan.

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