Mounting NPA in Indian Banking System

Abstract

The accelerating rate of NPAs in Indian banking system has been prevailing since it was recognised officially on the recommendations of Narashimam Committee in 1991. The stressed assets in the books of banks are the result of corporate defaults. Recently, the NPAs have been mounting due to the multiple factors such as the increasing number of wilful defaulters, the strict NPA recognition norms and economic slowdown caused the outbreak of COVID19. However, the RBI and Government of India have taken measure to contain the swelling NPA in the form of recovery regime, time-bound resolution of bankrupt entities, recapitalisation of PSBs, merger, reorganization and privatization of PSBs. Despite all the efforts, government is not able succeed satisfactorily although the IBC Code 2016 did perform well by recovering 61% of the total recovery made during 2018-19. Henceforth, the RBI and Government needed to take immediate and result oriented actions.

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Background

Banking system is the backbone of any economy. Many countries went into depression due to the bank crises. Corporate defaults don’t directly impact the GDP or industrial production but bank failure does. However the prime source of bank failures is corporate defaults e.g. Lehman Brothers default crisis emanated recession across the globe beginning from USA (Giesecke & Schaefer, 2012). Bank fails when it has stressed assets called NPA that reduces not only the profitability of the banks but also erodes the net worth of it. The NPA is growing like a disease that is taking the Indian economy in its grips. 

 
Corporate defaults are the main cause of mounting NPA in India. Unlike the USA, Indian firms get their projects, working capital financed from commercial banks; whereas the firms in USA prefer corporate bonds to raise capital (Giesecke & Schaefer, 2012). The burgeoning NPA can be a result of siphoning of funds by Firms, the constant business losses, government practice to write-off previous NPAs, extending loans to large corporations without evaluating their repaying capacity and the viability of projects that the banks are financing, the Financial Crisis of 2008 due to which the banks’ massive investment in large government projects or infrastructure projects got stuck when these projects stalled because of economic downturn (Ray, 2018).

Upward trend of NPA

India stands at 2nd position with 9.5% GNPA after Bangladesh that has 9.9% GNPA in 2018 amongst other Asian Countries namely China, South Korea, and Singapore that are having minimum GNPA which range from 0% to 2% in the same year. The detail of GNPA of all Asian countries is provided in the figure given below (Aryan & Raman, 2020).

Sources: World Banks
Fig 1

According to The Financial Stability Report of June 2016, the GNPA rose to 7.6% in FY 2016 from 5.1% in FY 2015. The fig 4 given below depicts the trends of GNPA in the Indian Banking Sector from 2002-03 to 2015-16 as depicted in the figure given below. NPA as of March 2018 was 10.3 trillion which was 11.2% of the total advances of the banks in which the NPA of PSU banks was Rs.8.9 trillion (RBI, 2018). Since the adoption of the 4 R strategy, the soaring GNPA has reduced to Rs 7,89,569 crore in FY 2019 and the PSU banks recovered 1,27,987 crore bad loans (RBI, 2019).

Sources: RBI
Fig 2

The pandemic fuelled the NPA problem during the outbreak of pandemic in 2020. Subsequent to the lockdown imposed from March 2020 to June 2020 the GDP contracted; the government incurred fiscal losses due to reduced revenues and higher health expenditures. Further, the facilitation of 3 months moratorium period to the borrowers has inflated the NPA. As per the Financial Stability Report, RBI GNPA is anticipated to increase from 8.5% in March 2020 to 12.5% by March 2021 (Dhar, 2019).

As depicted in Figure and the data reported by the various reports the NPA of Indian banks are in the upward trend. Particularly after 2008-09 the proportion of NPA remained steady for the 4-5 years till FY 2014-15. It increased steeply in 2016-17 due to the transparent recognition of NPA practice implemented by banks after AQR. The proportion of NPA came down in FY 2019 to grow rapidly in 2020-2021 due to the imposition of lockdown and outbreak of the pandemic (Ganatra, 2020).

Causes of NPA

The growth of Indian bank’s NPA is a threat to the Indian banking system and the nation's economy as whole. The Indian private and public sector banks are equal contributors to corporate debts, but according to the Financial Stability Report June 2016, the public sector has chronic NPA than the private sector banks. The root causes of the higher NPAs in PSBs is the political influence and corruption that helps large corporations for sanctioning and weaving off the loans, least accountability on the board members of PSBs, lax nature of the PSBs employees and administration (Harani & Mutyala, 2019)Therefore, lately the government proposed to privatize some of the major public sector banks for reducing stressed assets. It is comprehended from the given Figure 1 that from FY-2014 to FY-19 the amount of PSBs NPA remained high relative to private and foreign banks in the range from 86.6% to 79.2%. The advances extended by PSU banks in FY 2008 was 18, 19,074 crore that rose to 52, 15,920 in the FY 2014 which was the highest amongst other BRICS countries (Kaur, 2020).

Sources: RBI
Fig 3

As per the IMF report published in September 2018, the NPA of the Indian banking sector stands at 5th position in the world as of 30th June 2018. According to the data published by the RBI corporate defaults of non-priority sectors turned out as NPA rather than the priority sectors. This is evident from the Figure 2. Figure 2 presented the NPAs of priority and non-Priority sectors from FY 2010 6to 2017, the non-priority sectors performed poorly throughout the selected years. Despite of these evidences the banks extends loans quite easily to the non-priority sectors (Goyal, 2020; Mohanty, 2020).

Sources: RBI
Fig 4

The rapid growth of NPA is the result of over dependence of corporate on PSBs and the reliance of bank on non-priority sectors to earn interest income than on priority sectors. Other than this, there are multiple factors that have contributed to the inflated NPA of PSBs and non-priority sectors which include weak corporate governance structure at corporate bodies as well as the PSBs. Furthermore, underreporting and window dressing practices followed by the commercial banks made it difficult for the RBI to get the true picture of NPA which kept the level of NPA stable till 2014-15 (Upadhyay, 2019) (Mukhopadhyay, 2018).

Impact of NPA

The NPA impacts the profitability and lending capacity of the banks. The bank with surging NPA amount faces deteriorating ROA, pay-out ratio, and net income ratios that trembles the confidence of the stakeholders in the banks. RBI suggested banks to practice stringent provisioning against the stressed assets that hampers the credit supply in the economy (Ray, 2018). Resultantly, the lending rates shoot up that discourages the investment in infrastructure and industrial projects as well as retail consumers that ultimately reduce the aggregate demand in the economy for automobiles, residential of commercial properties, and electronics devices. Consequently, the GDP growth decreases yet the inflation elevate (Mukhopadhyay, 2018).

Government Initiatives to Reduce NPA and Corporate Default

The RBI releases prudential norms from time to time for transparently recognising and classifying the bank’s assets, for managing the credit risk following the recommendations provided by the Narasimham Committee 1991 for the reduction of NPAs (Sabnavis, 2021). Later on, the Government of India and RBI have taken various initiatives by forming various committees, issuing guidelines for recuperating the mammoth of NPA. The other key provisions of the Narasimham committee are reduction in Statutory Liquidity Ratio and Cash Reserve Ratio, defining the priority sector and deregulation. The measures taken so far by the policymakers are creation of Lok Adalats, SARFAESI Act and Debt Recovery Tribunals, Assets Reconstruction Company (ARC), Corporate Debt Restructuring (CDR), and Credit Information Bureau. Such measures have been adopted by the commercial banks on the recommendation of RBI to recover NPAs, to resolve distressed corporate debts and to realise the unresolved long term stressed assets of banks. The data reported by RBI as depicted in Figure 2 revealed that the SARFAESI Act and Debt Recovery Tribunal worked considerably well than the Lok Adalats concerning the recovery and liquidation of NPAs (Ibrahim & Thangavelu, 2014) (Mukhopadhyay, 2018).

Sources: RBI
Fig 5

The Basel Committee 2006 provided various mechanisms to battle the heightened NPA across the countries and managing efficiently the credit risk at the institutional level. Few principles suggested by the committee are establishing a credit risk mechanism to administer measures, to monitor the credit sanctioning and firm’s credit risk evaluation process, to maintain capital adequacy against the risk-weighted assets on the regular basis (Subbarao, 2019), (The Basel Committee, 2006).

The SARFAESI Act, Lok Adalats and DRTs were working satisfactory but it would take around 4-5 years to resolve, recover or liquidate the stressed assets of banks. To overcome this shortcoming of these forums the government passed Insolvency and Bankruptcy Code 2016 (IBC) (BL, 2020). The IBC was enacted to initiate the time-bound liquidation process of defaulted, bankrupted firms under the supervision of NCLT and also to speedily recover the stressed loan accounts. The amount of NPA recovered by IBC is 61% of the total recovery made by the scheduled banks in 2019-20 that was 56% in 2018-19 followed by SARFAESI ACT the DRT and Lok Adalats (BusinessLine, 2019).

The Asset Quality Review (AQR) an initiative taken by the Govt. of India in 2018 exhibited high incidences of GNPA. The GNPA of public sector bank from FY 2015 to FY 2017 to FY 2018 rose from Rs. 2,79,016 crore to 6,84,732 crore, to 8,95,601 crore. The 4 R strategies is the recognition of NPA, resolution of stressed assets, recapitalisation of PSU banks and introduction of further reforms in the banking system of India (PIB, 2019). Following the recommendations of AQR the Government of India launched Indradhanush scheme in 2015 that allocated 70000 crore in the union budget to recapitalise the PSBs by the 70000 crore in parts from 2015-16 to 2018-19 (Sikadar, 2020) (PIB, 2019).

The Government off lately has taken some measure to target NPA that are demonetization, recapitalization and merger of PSU banks. Vijaya Bank, Dena Bank merged into Bank of Baroda on April 1, 2019. However, the result of such reforms is yet to be observed (Pradhan, 2021).

Sector-wise Analysis of NPA

According to the Credit Suisse Report 2015, the expanding NPA in Indian Banks is caused by the defaults of 10 large Indian corporates which belong to construction, steel, metals, infrastructure, and textiles sectors. The balance sheet of 10 Public sector banks in the FY 2017 demonstrated 23% of loans extended to the non-priority sector that turned bad in FY 2018 (Dhar, 2019) The banking sector invested a mammoth amount of funds during the boom period in the Indian economy which witnessed 9% GDP growth (2004-05 to 2008-09). Some specific industries like mining, iron and its ancillaries crashed since the projects stalled due to financial crisis and environment issues.

Similarly the aviation sector e.g. the Kingfisher Airlines made a huge loss to SBI and lately Jet airways India’s 3rd biggest aviation firm defaulted in 2018. These firms could not even pay the salary of their staff and had to halt their operations (Upadhyay, 2019b). The loan granted to infrastructure and telecom sectors during the same period also turned NPA as well. Further, the depreciation of the Indian Rupee against the dollar put more weight on the spiralling NPA (Pradhan, 2021), (Department of Economic Affairs, 2017). The McKinsey and Credit Suisse report highlighted the most debt ridden and risky sectors in 2017 that have 43% probability to default in the payment of their long term loan. The outlined sectors are industrial, energy, real estate, material, telecom, metals, power and textiles (Dhar, 2019).

The default risk sectors pointed out in the various reports are the major sector that contribute the most in the GDP of the country and encapsulates the maximum number of listed and unlisted public and private firms that avail the major portion of their capital from Indian commercial banks. Therefore, the default and NPA emerges from these sectors can jeopardize the entire economy with 3600 effect.

Recommended Corrective Measures

The sell a 51% stake of 6 PSBs to the private sector has been proposed. However, this is not the immediate and reliable solution of the current NPA problem. Rather the banks specifically PSB should adopt certain practices to come out from the vicious trap of NPA and corporate default (Subbarao, 2019).  

• To limit the excess credit supply by imposing stringent monetary policy. 
• The bank should evaluate the credit risk of the corporate borrowers by assigning trained employees instead of relying on some third party agency. 
• Banks should practice investigative auditing to detect fraud, illegal diversification of money.
•  Establishing effective corporate governance at PSBs.
•  Provide more power and liberty to the Insolvency and Bankruptcy Code 2016.
•  Effectively managing fraudulent cases such as PMC, HDIL, PNB, DHFL, ICICI-Videocon, IL&FS, Yes Bank, and NSEL. These scams envelope approximately 32,361 crores of stressed assets in 2018.
•  Stop writing off the NPA as it has a two-tier effect, firstly it makes losses to the depositors and requires the infusion of the public money in the form of recapitalisation by the government in PSBs. RBI reported that Indian banks had written-off Rs 1,56,702 crore ($ 101) of NPAs during December 2018.
• Stop providing moratorium period, the SBI research paper 2020 provided that 70% of the total moratorium facility is availed by big corporate that are having efficient debt-equity ratio but later they declare themselves wilful defaulters.
•  Avoid restructuring of corporate debt since the CDR was proved not less than a disaster and a mechanism of concealment of NPAs. Moreover, it has a negligible recovery rate.
•  Banks can use unclaimed deposits as capital.
•  To make reduce CRR and SLR.  
• Banks can refinance themselves from RBI by adopting the practices conducted by the US Federal Reserve bank under which the Federal bank purchased the stressed assets during 2008-09 of the US commercial banks for $700 Billion.  
• RBI suggested banks to adopt strict Provisioning practices and report less profit for the losses incurred by banks due to NPA.  
• As a proactive measure, the loan should not be extended for the next 5 years as a penalty to the wilful defaulters.  
• The banks must penalised and the parties involved in the violations of legal compliances while sanctioning the loans to the corporate that.  
• The most vital steps should be taken by the RBI is to get rid of internal corruption, political influence/interference in the matters of sanctioning and writing off loans of the corporates.
  

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Ms Deepika Verma
Assistant Professor
Sri Aurobindo College (Evening)
University of Delhi 

 

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Article History:-

Online Submission: 10th July 2021
1st Peer Review Comment: 12th July 2021
1st Revised Submission: 13th July 2021
2nd Peer Review Comment: 17th July 2021
2nd Revised Submission: 19th July 2021
Acceptance of Article: 19th July 2021
Published Online: 19th July 2021