Home / Opinion / NPA resolution: a rough road ahead

The most important takeaway from the latest “Financial Stability Report", released by the Reserve Bank of India (RBI) last week, is that conditions in the Indian financial system are expected to deteriorate further before they improve. There is more pain ahead.

Here are a few important pointers. Gross non-performing assets (NPAs) rose from 9.2% in September 2016 to 9.6% in March 2017. Stress tests conducted by the Indian central bank indicate that this number could rise to 10.2% under the baseline scenario. The indicator of banking stability worsened over the second half of fiscal year 2017—with measures of asset quality and profitability providing the most cause for concern even while there has been a modest improvement in capital adequacy, thanks to the private sector and foreign banks.

The situation in public sector banks is especially worrisome. Capital adequacy is under strain. Return on assets is negative. So is return on equity. More than a quarter of the loans given by public sector banks to industry (thus excluding loans to agriculture, services and retail consumers) are under stress. All this is a reminder of the fact that government banks are at the epicentre of the larger banking mess.

The financial authorities have now decided to focus on a few large problem accounts that are weighing down the Indian banking system. Does this make sense? The “Financial Stability Report" has some useful data on this issue as well.

Fifty-six per cent of the loans given out by Indian banks have gone to large borrowers—but they account for a massive 86% of gross NPAs. In that sense, the new strategy of focusing on large defaulters makes good strategic sense. Bad loans are concentrated in a few firms in a few sectors such as telecommunications, power, infrastructure and steel.

All this is a good backdrop at a time when the NPA resolution process has reached a critical stage. The RBI has already identified 12 big accounts for quick resolution, under the powers given to it by the recent presidential ordinance (though this publication continues to believe that the government, as the owner of three-fourths of the banking sector, should not have pushed the regulator into the resolution of individual bad loans, but done the job itself).

These 12 accounts are the source of a full quarter of the total NPAs of the banking system. Lenders have been instructed by their regulator to use the provisions of the new Insolvency and Bankruptcy Code to file insolvency proceedings against companies. Lenders have approached the National Company Law Tribunal in at least two of the 12 accounts identified by the RBI.

What happens in the months ahead will be watched with interest—especially as a test case for the new bankruptcy process, which is as yet untested. But what is important right now is that for perhaps the first time in recent Indian financial history, powerful firms are living under the threat of liquidation. The new bankruptcy law allows defaulters 270 days to come up with a credible plan to repay loans—and lenders can initiate liquidation if companies fail to do so. In other words, the design of the bankruptcy law ensures that companies cannot merely kick the can down the road. That is welcome.

Any banking clean-up will eventually require capital—lots of capital. Credit rating agency Moody’s said in a recent note that the 11 public sector banks rated by it will need external equity capital of unto Rs95,000 crore, far higher than what the government has budgeted as capital infusion for all the banks it owns.

Some analysts have now begun to argue that the Indian investment cycle is set to turn. It is well known that the economic recovery cannot build momentum unless private sector investment revives. Such a revival will be very difficult unless the twin balance-sheet problem—over-leveraged corporations and undercapitalized banks—is solved credibly. The “Financial Stability Report" indicates that the road ahead will still be a rough one. The recent moves to take large defaulters towards insolvency proceedings shows that some firm action is finally being taken.

A banking clean-up plus corporate deleveraging are critical for a more robust economic revival led by investment rather than just consumption.

Is the RBI-led banking clean-up likely to be effective? Tell us at

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