Shyamal Banerjee/Mint
Shyamal Banerjee/Mint

Is the financial sector’s asset quality getting worse or better?

It's true that the aftermath of the asset quality review is giving us a clearer picture of what lies within the banking sector

At a press conference on Tuesday, 26 April, after declaring the fourth quarter earnings for financial year (FY) 2015-16, Rajiv Lall, chief executive officer of IDFC Bank Ltd, interrupted his chief financial officer to make a point. The bank had just reported a jump in gross non-performing assets (NPAs) to 6.16% from 3.09% in the previous quarter. The question was on this surge in bad loans. Television channels were running tickers saying “Asset quality worsens". Lall interjected. “An increase in the gross NPA number doesn’t mean that asset quality has worsened. We have provided for all these bad loans. So asset quality is actually improving," said Lall.

Lall’s comment makes for an interesting debate at a time when most banks are reporting an increase in their reported bad loans. Should we see this recognition (which, by the way, is the result of a regulatory diktat) of stressed assets as a positive and argue that asset quality management at banks is improving? Or should we be alarmed at the level of stressed assets that have existed in the system without an upfront declaration?

Bankers argue that it is the former. Their contention is that they were following the law of the land and classifying loans as NPAs when dues were delayed by more than 90 days. That’s what the Reserve Bank of India (RBI) rule says. Never mind that companies had made a habit of delaying payments till virtually the last day. Let’s also ignore the fact that the asset quality review conducted by RBI detected questionable practices such as round-tripping of funds by companies and the repayment of short-term loans through overdraft facilities. All this was leading to an understatement of bad loans in the system and hence inadequate provisions.

Now that RBI has tightened its stance, we are doing as the regulator tells us, bankers say. Sure. But, the point worth noting here is that RBI has actually not changed any rules. It is just ensuring that rules are followed and that they are followed in the spirit of the law rather than the letter.

An analyst who covers the banking sector scoffed at the idea that this process of purging (so to speak) should bring greater confidence around the asset quality of banks. It’s like putting a band aid on an injury and saying that there was no injury to begin with, said this analyst requesting anonymity.

It’s true that the aftermath of the asset quality review is giving us a clearer picture of what lies within the banking sector. But it equally makes us question why banks were not disclosing this picture to begin with and why RBI’s bank supervision department didn’t catch this earlier. Even if you find that argument subjective, there are other reasons to believe that the worst of the asset quality problems are not behind us.

On 22 April, The Financial Express, reported, based on RBI data, that more than 3 trillion in loans are classified under the SMA-1 category (accounts where repayments are overdue by 30-60 days) and another 3 trillion in loans are in the SMA-2 category (accounts where repayments are overdue by 60-90 days). It is only reasonable and prudent to expect that some part of this will find its way into the NPA bucket over the course of this year. As of end-December 2015 quarter, gross NPAs of the 39 listed banks were at 4.38 trillion. This number is sure to rise—both because of the one-time hit from the asset quality review and also due to the organic growth in NPAs.

There is another reason to be cautious. The asset quality review has so far only revealed the asset quality picture of banks. What about non-banking finance companies (NBFCs)? Do NBFCs have similar issues hidden in their books? According to RBI’s December Financial Stability Review (FSR), there were 11,781 NBFCs registered with RBI. Of these, there are 210 Systemically Important Non-Deposit accepting NBFCs (NBFCs-NDSI). The aggregate loans and advances of the sector grew by 14.2% year-on-year in September 2015, after a 16.3% growth in March. The gross NPAs of the NBFC segment were at 3.5% as of September, says the FSR.

To be sure, the NPA rules for NBFCs are less stringent than those prescribed to banks. Until last fiscal, only accounts overdue by more than 180 days were classified as bad loans at NBFCs. This will be brought in line with the 90-day NPA rule that banks adhere to in stages by March 2018. Even so, RBI would do well to scrutinise the balance sheets of NBFCs, particularly those lending to sectors such as infrastructure that have been the source of a lot of stress.

There is also the issue of the asset quality of Life Insurance Corp. of India’s (LIC’s) debt portfolio. On Thursday, 28 April, Mint’s Ravi Krishnan highlighted the potential concerns emerging from LIC’s lending activities ( ). RBI, together with the Insurance Regulatory and Development Authority of India, may need to comb through LIC’s books as well to snuff out any asset quality concerns that may exist there.

To sum up, despite what bankers say, it’s going to be a while before anyone can confidently say that the asset quality of the Indian financial sector is improving. And no, most don’t see the current coming-out of bad loans as a positive.

Ira Dugal is assistant managing editor, Mint.

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