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Between 1997 and 2001, gross NPAs of the banking system were 12.8%. After setting aside money, net NPAs were 8.4% of total loans. Photo: Pradeep Gaur/Mint
Between 1997 and 2001, gross NPAs of the banking system were 12.8%. After setting aside money, net NPAs were 8.4% of total loans. Photo: Pradeep Gaur/Mint

PSU banks: who will stem the rot?

RBI is increasingly getting worried about the rising NPAs of public sector banks

India’s central bank is increasingly getting worried about the rising bad assets of public sector banks, which roughly account for three-fourths of the assets in the 80 trillion banking industry. It has been playing the typical good cop-bad cop game. While Reserve Bank of India (RBI) governor Raghuram Rajan is blaming the corporate sector for taking the banks for a ride and occasionally getting mildly critical of bankers, his deputy K.C. Chakrabarty is lambasting the banking community for poor credit appraisal and lousy monitoring of loan accounts.

At a recent bankers’ meeting, Rajan hinted at bank chairmen with limited tenure dealing with stressed assets by evergreening them and leaving to their successor to deal with it, while Chakrabarty was blunt in saying that wrong appraisals were leading to diversions, over-leverage, fraud and non-performing assets (NPAs), and “they are all inter-related". Evergreening refers to the practice of giving fresh loans to pay off the old loan of the same bank or other banks. Chakrabarty, who was a commercial banker and chairman of Punjab National Bank before moving to RBI, has tracked the growth and development of bad assets in the Indian banking system in the past two decades through a brilliant PowerPoint presentation that he had made at the bankers’ meeting.

In 1985, for the first time, India introduced a health code system, categorizing bank loans under eight heads, ranging from satisfactory to bad and doubtful. Subsequently, in 1992, after the nation embraced economic liberalization, new norms were introduced classifying bad assets into substandard, doubtful and loss, and banks were asked to set aside money for such assets. Finally, in 2004, the 90-day norm was introduced for bad assets, which stipulated that a loan would turn bad and a bank has to set aside money when the borrower is unable to service it for three months.

Between 1997 and 2001, gross NPAs of the banking system were 12.8%. After setting aside money, net NPAs were 8.4% of total loans. The comparable numbers in September 2013 are 4.2% and 2.2%, respectively. By any yardstick, they are not alarming, but what is worrying is that some banks are accumulating more bad assets than others.

For instance, in March 2003, the public sector banking industry accounted for 74% of total bank loans and their share of gross NPAs was 75.4%. A decade later, in March 2013, their share in banking loans has been only marginally high at 75.3%, but when it comes to gross NPAs, it is 86.1%. In contrast, new private banks’ share of bank loans was 6.9% and that of gross NPAs 4.2% in 1993. In 2013, while their share of loans has risen to 14.7%, their contribution to gross NPAs has dropped to 6.8%.

Another interesting point to note is that the reduction in NPAs is more due to loan write-offs than actual recovery. In the past six years, between 2007 and 2013, the banking system accumulated 4.95 trillion fresh NPAs and reduced the pile by some 3.5% trillion. Of this, 1.41 trillion reduction is due to loan write-offs, while actual recovery is 1.18 trillion. The rest is due to upgradation of assets. Particularly after the 2008 global credit crisis, more assets have been turning bad and striking off loans contributing significantly to decline in NPAs, reducing incentives to banks to improve recovery.

Gross NPAs in themselves are not a problem, but in combination with restructured advances, they will soon pose a threat to the Indian banking system. The combination of so-called slippages, or fresh loans turning bad, and restructured assets now constitute 7.1% of public sector banks’ loan book against 5.2% in March 2009. In the same period, the new private banks’ slippages and restructured loan combination has dropped from 3.9% to 1.8%. Public sector banks seem to be too eager to restructure loans as they are treating this as an NPA-management tool. If one adds gross bad assets and restructured loans, the pile accounts for 11.1% for public sector banks, more than double of what it had been in March 2009. For new private banks, it has been 3.1% in 2013, sharply down from 5% in 2009.

Another interesting aspect of Chakrabarty’s presentation is that NPAs had started rising from 2007, before the global financial crisis. This debunks the theory that bad loans have been growing because of economic slowdown. Banks with high credit growth between 2004 and 2008 have accumulated higher bad assets in the past five years. This is most pronounced in public sector banks because they suffer from “structural deficiencies" related to the management and governance issues.

The credit management and monitoring in these banks are not good and they have clearly failed to tackle the menace of bad assets the way new private banks and foreign banks have done. Extending the governance issue, Chakrabarty’s presentation also refers to the increasing incidence of frauds in banking. At least 64% of fraud cases are related to loans. Between 2011 and 2013, 242 fraud cases involving 16,690 crore have been detected and public sector banks account for 201 cases ( 14,577 crore).

Nobody can gloss over the fact that all banks are operating in the same economic environment, but public sector banks are more vulnerable because their systems and processes, and even leadership need to improve. But can RBI disown its responsibility? It inspects the books of banks and the RBI governor chairs the appointment panel that identifies heads of banks. Indeed, the Indian central bank has been bashing up public sector banks from every fora and talking about their poor credit appraisal, monitoring and even governance. The awareness of what is happening in its backyard is welcome, but it will be nice to see the regulator owning up the responsibility and taking actions to stem the rot. Only talk serves no purpose.

Tamal Bandyopadhyay keeps a close eye on everything banking from his perch as Mint’s deputy managing editor in Mumbai. He is also the author of A Bank for the Buck, a book on HDFC Bank. Email your comments to bankerstrust@livemint.com

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