If someone asks you to look around and count the number of red or nearly red objects in your vicinity and thereafter asks you how many green objects you counted, you are unlikely to have an answer. The counting of red objects took up so much of attention that the green objects escaped notice.
Something like that could be on in the banking sector right now. We can save the details for another column, but infrastructure non-performing loans (NPLs) have justifiably consumed a lot of attention. There are chinks elsewhere in corporate India, too, but NPLs there get dumbed down to a consequence of the general economic downturn, and do not engage us actively.
But the banking sector will be doing a great disservice to itself if it does not prepare for significantly heightened retail NPLs.
Let us first examine why this could be termed alarmist. Retail NPLs have held up remarkably well. HDFC Bank Ltd’s retail NPLs moved from 0.55% in March 2011 to 0.52% in March 2012, ICICI Bank Ltd’s from 7.4% to 6.3% during the same period, State Bank of India’s (SBI) declined from 2.65% to 2.3%, and these in a year when overall NPLs increased. But as if symptomatic of a false dawn, SBI’s retail NPLs went back up from 2.3% in March 2012 to 2.59% in June 2012. (Only the temporal trends matter—cross-lender comparison should be avoided due to differences in definition and writeoff policies).
The explanation is only partly the general consumption buoyancy in the economy. The real reason is the concerted effort of banks themselves, largely private banks, as well as maturing of the regulatory apparatus, especially credit bureaus. After the bad experience of 2008-09, banks tightened credit appraisals. More importantly, quite in contrast to the pre-2008 period, the banking system has kept retail loan growth at below the overall loan growth. This has been a remarkable example of credit control amid environmental adversity.
One reason for the apparent complacency about retail loan quality is wrong conclusion from the rather deceptive difference between the 2008 days and now. For sure, there is a difference. The 2008 retail fiasco was a product of excessive lender aggression and sweetheart deals between some foreign banks and defaulters that vitiated the credit culture. The fact that credit bureaus were in infancy meant little prescience was forthcoming from them. We are now better off on both fronts.
However, what is generally forgotten is that in 2007, consumer price inflation had shot up to uncomfortable levels—alongside India Shining, there was an India Whining that had difficulty in paying monthly instalments. The burden was aggravated by rising prices and rising interest rates. So there was an issue of ability to pay, along with willingness to pay. It is much the same now with the economic environment; more on that later.
Second, one key reason for ballooning retail NPLs in 2008-09 was the damage to the recovery environment as the Reserve Bank of India (RBI) clamped down on lenders’ recovery practices after reports of borrower harassment followed by suicides. The important point to note is that the banking system handled this in a oblique fashion by clamping down on further loans, but not through an improvement in the recovery climate that remains broadly the same even now. The recent incident of the alleged kidnapping of a 42-year old (woman) defaulter by recovery agents in Kolkata shows that the last word has not been said on the RBI-lenders-courts-borrowers tussle.
It is somewhat naive to think that all our problems will continue to be investment-driven and consumption will continue to support the economy—the key reason for the robustness of banks’ retail portfolios till now. The fact that consumption has started flagging is evident in decelerating sales of select consumer products, reduced confidence indices, declining service sector growth rates in the gross domestic product basket, falling car sales and so on. Up to a point this slowdown translates just to slower growth of retail loans, but when it extends to job losses or salary cuts, NPLs begin to get uglier.
This is the worst time for banks to cut retail loan rates with the hope of prodding growth, the kind of movement that State Bank of India seems to be leading. Apart from the rather tenuous correlation between rates and growth that this author has often argued about, this can result in banks dropping their guard on loan quality. At least, continuation of relatively high rates can help to turn away some marginal borrowers who may be more prone to default.
Lenders need to be vigilant about every pocket (geographical, borrower category, end-use) of lending because it needs only one spark to ignite a fire. NPLs are a phenomenon where exceptions create the rule: it is not about averages—a large number of very good borrowers does not algebraically offset defaulters.
Dipankar Choudhury has been a senior research analyst on financial services as well as other sectors at various investment banks, and is currently an independent consultant focusing on banks and financial services.