Thursday, December 19, 2019

Divergence of Bad Loans and their Provisioning and NPA in Indian Banking System

Slowdown in Indian EconomyNPAs have become malaise for the whole banking system in India. For many years, RBI is on drive to clean the banking system but quarter after quarter NPAs are being recognized by banks themselves or detected by RBI. A recent RBI assessment reveals that many lenders including SBI and PNB have been found to be under reporting bad loans as well as their provisioning in last financial year 2018-19. This list democratically includes both the private as well as public sector banks. Those names include UCO Bank, Yes Bank, Union Bank, and Lakshmi Vilas Bank (livemint, 2019). It is quite possible that the final list may many more name names. Similar trend was found in last financial year also. Most importantly the amount of divergence had been very high. For example, in case of SBI, this divergence is tune of ₹ 11,932 crores on account of bad loans and ₹ 12,036 crores towards provisioning. That simply means if these numbers had been adjusted, the bank would have reported a loss of ₹ 6,968 crores than its reported profit of ₹ 862 crores. It had been a quiet practice for long in the Indian banking sector but under wraps and is not just limited to Indian market. However the scary situation is forcing RBI to take serious cognizance of this issue.

Like every central bank across world, RBI assesses the compliances by banks with extant to prudential norms on income recognition, asset classification and provisioning (IRACP) every year as part of its routine. Towards this end RBI issues directives for different purposes from time to time depending on prevailing realities in banking system and economy. Asset quality review (AQR) followed by directives in divergence on bad loans and their provisioning are part of this exercise. Considering the magnitude of the NPAs problem RBI has already relaxed the directive on divergence on bad loans and their provisioning.

Alerted by gravitating problems of NPAs, RBI is taking all possible measures to clean up banking system. It first came up with asset quality review provisions but could not yield desirable results in checking NPAs. RBI had to review its strategy to come up with tougher directive on divergence of bad loans and their provisioning which was later relaxed to accommodate the tough situation of banking sector. Following the signals given by RBI, to tighten the norms for asset quality disclosures and to protect the interests of equity investors in these financial institutions, the SEBI also directed publicly-traded banks to disclose such divergences within a day of receiving the final report from the banking regulator.

Banking system uses this practice with the hope that those bad loan accounts would turn into standard assets over time. However with the help of this practice, the real financial positions of these institutions are withheld for some time from RBI as well as the market both. This glossy and superficial picture is presented to avoid knee jerk reaction from the market and RBI. Like all other publicly traded companies, banks too have the pressure of increasing or at least maintaining profitability so that value of their stocks can be maintained at least. So in this window dressing practice, stock market does have an invisible role to play.

Apart from the under-reporting of bad loans and their provisioning, banking system in India has been generously engaged in restructuring bad accounts with the purpose to clean NPAs so that recognition of NPAs can be postponed than turning those NPAs into standard assets (Upadhyay, 2019 a). In the process often easier terms are offered. This practice of restructuring of bad accounts on easier terms has huge cost to the borrowers as well as the lenders. This practice of restructuring is considered as window dressing but indirectly is a sort of window dressing.

These two practices are helpful in short term for the managers managing these bad accounts. But for the financial institutions, these practices are often very costly. The increase in NPAs not only proves costly to the financial institution, but the economy also. It negatively affects the whole risk management practices in the bank by adversely impacting the profitability, liability management and capital adequacy ratios. Apart from this, increase in NPAs decreases return to shareholders and raises question on credibility of the bank. Also the increase in NPAs results into credit contraction which decreases the availability of funds in the economy and lesser opportunities for the banks and entrepreneurs. And when unchecked for long, it turns into vicious cycle. As a result of these continuous practices over a long period of time, not only the risk in the Indian banking system has increased but the regulators being in dark could not respond to the accumulating problems which have resulted into unnoticed slowdown in Indian economy (Upadhyay, 2019 b). 

Today the whole banking sector in India is plagued with the problem of NPAs. There is hardly any bank that does not have very high level of NPAs. This situation did not arise in one or two years. It is result of consistent under-reporting of bad loans and their provisioning as well as wrongful restructuring of bad accounts with the sole purpose to postpone the recognition of NPAs over a long period of time. This puts the role of auditors under question. Most surprising fact of the whole phenomenon is that RBI either failed to trace these under-reporting earlier or it did not care much about it. However the case of PMC Bank narrates that it was lapse on part of RBI (Dalal, 2019). Whatsoever may be the case but failure of RBI to act timely to this malaise has costed to the whole economy which has been coupled by the government reforms in haste (Upadhyay, 2019 c).

Weak capitalization of the public banks will have additional burden on public exchequer when economy is under tremendous pressure because of slowdown in economic activities. In such a scenario, today, the credibility of banking system is being questioned by depositors through many media reports as well as social media that the depositors’ money is not safe in banks. This is really scary for an economy which took decades to win the faith of people.


  • Dalal, S. (2019, December 18). PMC Bank: Red Flags of 2015 Forgotten over the Next 3 Years! . Retrieved from MoneyLife:
  • livemint. (2019, December 10). SBI gets a ₹11,932 crore bad loans jolt from RBI. Retrieved from livemint:
  • Panchal, S. (2019, December 13). After SBI case, bank auditors face NPA divergence heat. Retrieved from Forbes India:
  • Upadhyay, R. K. (2019 a, April 21). Management and Regulators Failed Jet Airways . Retrieved from The Deliberation:
  • Upadhyay, R. K. (2019 b, August 25). Slowdown Creeps in Indian Economy. Retrieved from The Deliberation:
  • Upadhyay, R. K. (2019 c, October 21). Causes and the Nature of the Slowdown in the Indian Economy. Retrieved from The Deliberation:

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