Conventional wisdom says all bad loans are created when the going is good for the banking system. Going by this dictum, commercial banks in India should have piled up huge distressed assets by this time. After all, banks’ loan advances have grown at around 30% for three consecutive years and the industry has never had a better time.
Fortunately, their distressed assets are not growing as yet.
All major banks, except for the Delhi-based Punjab National Bank, have announced their financial performance for the year ended March. Nine of them have actually brought down the level of net non-performing assets (NPAs) as a percentage of their loan advances to zero. Out of this pack, only two had declared zero net NPA in the previous year. This means that even more have joined the zero-NPA club, despite aggressively chasing loan assets. The growing resilience of the Indian banking system becomes clear when one takes a look at the movement of stressed assets over a five-year time frame. Among the 27 public sector banks, just one had over 15% net NPA and another two, over 10% in 2002. Among the rest, 15 had their net NPAs over 5% of their loan assets. The lowest net NPA in 2002 was recorded by Corporation Bank—2.31%.
Cut to 2007. Two of the 25 public sector banks that have announced their results have zero NPA, 13 have their NPA level at less than 1%, nine between 1% and 2%, and only one bank has stressed assets more than 2% of its total loan advances. For some of the banks, it has been a memorable journey. For instance, Dena Bank has brought down its level of net NPA from 16.31% in 2002 to 1.99% now. For Kolkata-based Allahabad Bank, the progress is from 10.57% to 1.07% in five years. The third public sector bank that had over 10% net NPA in 2002 is Punjab & Sind Bank, at 11.70%. It hasn’t yet announced its earnings for 2006-07. Last year, its net NPA was 2.43%.
The new generation private-sector banks, such as HDFC Bank Ltd, UTI Bank Ltd, Kotak Mahindra Bank and others, have never had a high level of NPAs as, unlike their counterparts in the public sector, they don’t have the legacy of bad loans on their books for decades. So, it is relatively easy for these banks to achieve the zero-NPA status. ICICI Bank Ltd is, however, a different fish in this kettle. Its stressed assets portfolio grew to close to 5.5% in 2002 following the merger of the former ICICI Ltd, the financial institution, with the bank. It has been able to contain its net NPA level at 1% in 2007.
Among the old private-sector banks, Dhanalakshmi Bank Ltd has brought down its net NPA from 11.66% in 2002 to zero now. The stories of Bank of Rajasthan, South Indian Bank and Development Credit Bank have been equally remarkable. Over the past five years, Bank of Rajasthan’s NPA is down from 8.86% to zero; South Indian Bank from 6.64% to zero and Development Credit Bank from 6.47% to 1.64%.
The entire story of the zero-NPA game is spectacular as these banks have not used the easiest way out to bring down their distressed assets. S.S. Tarapore, a former RBI deputy governor and the chairman of a high-profile panel that has laid down India’s path for capital account convertibility, was a strong advocate for narrow banking to fight the menace of rising bad loans. He wanted some of the weak banks to stop lending and focus on government bonds alone to build new assets. This, he felt, was the only way to keep them afloat as sovereign papers are zero risk. But, even the weak banks have grown their loan book between 60% and 100% over the last five years without compromising on the quality of assets.
Globally, non-performing assets are calculated as a percentage of a bank’s total assets. In the Indian context, they are always considered as a percentage of their loan advances and not the entire asset book. If one considers NPAs of Indian banks in the context of their entire asset book, the picture would turn even rosier as about 29% of their assets are zero-risk government bonds.
Indeed, keeping a hawk eye on the quality of assets has helped banks to bring down the level of their NPAs. But, there are key external factors too. Early this century, a corporate debt restructuring package helped them to recast over Rs40,000 crore loans that turned bad. It was done by bringing down the interest rate and stretching the maturity profile of such loans as well as replacing part of rupee loans with foreign currency denominated loans.
The major beneficiary of the restructuring is the steel industry. Riding high on the economic boom, those firms as well as other corporate borrowers have not defaulted in loan repayment in the past five years. Banks have also been aggressively allocating funds each year to cover the distressed assets. Allocation of such funds, or provisioning for bad debt, brings down the level of net NPAs. They have also been writing off bad loans and selling such loans at a steep discount to fellow banks as well as asset reconstruction firms that recover these loans and make money in the process.
The party will continue as long as Indian companies maintain their growth momentum. By bringing down their bad loans, the banks have already started getting a better valuation on the bourses. The consumers, too, will gain from this phenomenon as, with bad loans going down, banks can afford to bring down their loan rates. Banks do not earn any interest on their bad loans, but they need to provide for such loans. As the percentage of performing assets grows, banks’ interest income rises and hence they do not need to charge high rates on performing assets to subsidize the absence of interest income on bad loans. But, this is possible only if the fresh creation of bad loans is moderate and provisioning requirement to cover such loans is not too high.
Tamal Bandyopadhyay keeps a close eye on all things banking from his perch as the Mumbai bureau chief of Mint. Please email comments to firstname.lastname@example.org