Photo: Mint
Photo: Mint

Irrational exuberance before 2008 responsible for NPAs

In the five year period of 2006-2011, credit growth was in excess of 20% on a year on year, data collated by the Reserve Bank of India shows

New Delhi/Mumbai: The Indian banking system may have escaped relatively unscathed from the Lehman Brothers collapse in 2008 but the ‘irrational exuberance’ shown by bankers in aggressively lending to big projects in the boom period has caught up with the economy—it’s the origin of the current massive 10 trillion stockpile of bad debt.

The Lehman collapse impacted the repayment capacity of Indian corporates as well as Indian banks who had been lending indiscriminately to firms starting 2006 and were now staring at a huge pile of stressed loans. At the same time, the increasing integration with the global economy meant India could not escape the slowdown in global growth despite a loose money policy followed by the central bank and a fiscal stimulus package rolled out by the government.

The government’s aggressive push to infrastructure coupled with a rapidly growing economy saw Indian banks lend aggressively to firms without adequate due diligence. Banks did not insist on adequate promoter equity and funded highly leveraged projects. They failed to conduct their own checks on the feasibility of projects, often relying on the feasibility reports provided by promoters.

In the five years from 2006 to 2011, credit growth was in excess of 20% year on year, data collated by the Reserve Bank of India shows. Also, credit growth to industry was consistently higher than the overall credit growth till 2013-14 before slowing down.

Lending by banks to corporates despite high levels of leverage is what is US Federal Reserve chairman Alan Greenspan called “irrational exuberance" in the 1990s.

All this added to the stressed assets reported by Indian banks though regulatory forebearance enabled these banks to classify these accounts as ‘restructured accounts’ and delay their classification as ‘non-performing loans’, thus enabling banks to set aside less funds as provisioning.

A few years down the line, these accounts turned non-performing as large infrastructure projects failed to take off due to delays and lack of permission, and promoters failed to service the debt. A shadow over the allocation of coal mines, coupled with a slowdown in decisionmaking for fear of a probe by investigative agencies, worsened the climate.

Arundhati Bhattacharya, former chairperson of the country’s largest state-owned lender State Bank of India admits that banks should have followed tighter underwriting standards and anticipated crony capitalism.

“A lot of emphasis was given by the government on funding infrastructure and core sector. Because the banks had liquidity and things were going well, the standards of underwriting which should have been much tighter and should have anticipated many scenarios that subsequently played out were not followed," she said.

She added that banks did not anticipate many potential scenarios.

“The scenario that GDP would halve was not anticipated and neither was the scenario that certain approvals would take very long. The scenario that the approvals given will be cancelled by judiciary was not anticipated."

Indian banks are still dealing with huge level of NPAs. Gross NPAs in the banking system were at 11.6% of gross advances as of end March 2018. Taking into account the restructured standard advances, stressed assets in the Indian banking system were at 12.5% as of 31 March, the highest in the 10 years since Lehman. The gross NPA ratio for the industry sector is understandably higher. It was at 22.8% as of March 2018, as against 19.4% as of March 2017. The stressed assets ratio was at 24.8% as against 23.9% in the year earlier.

Though bankers say the NPAs have peaked, the RBI expects the gross non-performing loans for the banking system to further worsen to 12.2% by March 2019.

Karthik Srinivasan, Senior vice president at Icra Ltd said a large part of the current asset quality problem can be linked to the period of euphoria when banks lent money for various infrastructure projects that subsequently got into stress for a variety of reasons.

“The country needed huge investments around that time to improve the infrastructure and being a bank-driven economy, a large part of the same was funded by banks, especially the public-sector ones. The leverage levels for the public-sector banks had also increased sharply to over 2 times for many of them," he said.

But banks also chose to delay the recognition of the problem rather than addressing it head on. In a note to Parliament’s estimates committee, former Reserve Bank of India governor Raghuram Rajan who was at the helm from 2013 till 2016 pointed out how banks were happy to continue with the status quo through deceptive accounting.

“It was in everyone’s interest to extend the loan by making additional loans to enable the promoter to pay interest and pretend it was performing. The promoter had no need to bring in equity, the banker did not have to restructure and recognize losses or declare the loan NPA and spoil his profitability, the government had no need to infuse capital. In reality though, because the loan was actually non-performing, bank profitability was illusory, and the size of losses on its balance sheet were ballooning because no interest was actually coming in," he noted, adding that some part of the NPA problem could be attributed to malfeasance and corruption.

Pronob Sen, former chief statistician of India, said ever-greening of loans by banks the practice of advancing new loans to pay off old ones was another major reason for the NPAs remaining undetected for such a long period of time. “Short tenures for bank chiefs meant that they decided to evergreen the loan and pass on the problem to the next head and this cycle continued," he said.

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