India’s big bad loan problem

If there were any hopes about a quick end to India’s bad loan saga, the earnings season for the July-September quarter has dispelled them very quickly. Most state-owned banks which have reported their July-September quarterly earnings figures so far have witnessed asset quality pressures, which have impacted their profitability and loan growth.

But how severe is the Indian bad loan problem? A look at the ratio of bad loans or non-performing assets (NPA) across the world shows that India’s NPA levels place it among the worst-performing major economies of the world.

A comparison of the non-performing loan ratio of 25 large Asia-Pacific banks, which are part of the Bloomberg Asia Banks Large Cap Index shows that the large Indian banks have the worst NPA ratio when compared to their large cap peers in the region.

The three Indian banks included in the Bloomberg Asia Banks Large Cap Index are the State Bank of India, ICICI Bank and HDFC Bank, which are relatively in better shape compared to most of their domestic peers. Yet, India’s performance is worse than that of other economies in the region.

The major culprits behind the rise in bad loans over the past few quarters have been state-owned banks. The July-September quarter results for Indian banks so far show a continued divergence between the private and the state-owned banks. The net profit of most of the private banks (which have reported their results so far) rose in the September quarter even as state-owned banks reported higher provisioning for bad loans rose and consequently lower profits.

Among the private banks, Yes Bank, Kotak Mahindra Bank, IndusInd Bank and HDFC Bank reported growth in their respective net profits, in the range of 20-31% over the year-ago period. On the other hand, most of the state-owned banks so far have reported a decline in their profits for the September quarter compared to the year-ago period. While Central Bank of India and Bank of Maharashtra reported net losses for the quarter, the net profit for Syndicate Bank and Union Bank fell by more than 70% each. There were some exceptions in both categories such as the private lender Axis Bank, which posted an 83% decline in profit owing to increased provisions for bad debt, and public sector lender Vijaya Bank which witnessed a 34% rise in profit compared to a year ago. But overall, the state-owned banks have disappointed far more than the privately-owned ones.

The difference between the state-owned banks and private sector banks is starker when we compare their asset quality. Gross non-performing assets (NPA) as percentage of total loans and advances is higher in public sector banks than private banks and the trend appears to have continued in the September quarter as well, based on the results of major banks which have reported their quarterly earnings so far.

Mint calculations show that the weighted-average-of-NPA ratio is close to 11% for the eighteen major state-owned banks, much higher than the estimated 3.2% NPA ratio for six large private sector banks. The 11% NPA ratio for state-owned banks might be an under-estimate as it is partly based on April-June quarter results, given that several large state-owned banks are yet to declare their July-September quarter results.

To be sure, much of the recent decline in banks’ reported asset quality is attributable to recognition of legacy problems and does not imply that assets have suddenly turned sour over the past few quarters. The effervescent lending of the boom years and delayed recognition by banks forced the central bank to tighten norms on recognition of bad or impaired assets over the past couple of years.

The Reserve Bank of India (RBI) had announced the Strategic Debt Restructuring (SDR) scheme in June last year and subsequently conducted an asset quality review (AQR), forcing lenders to recognize more loans as non-performing and set aside more funds as provisions, leading to some nasty surprises.

The aggregate non-performing assets of the banking sector stood at ₹ 6.5 trillion, or 8.6% of loans, at the end of June 2016. Adding another 3.5% of restructured loans, the total amount of “impaired” debt in the banking sector increases to 12.1%, according to a 19 September Credit Suisse research report. The report also warned that another 4.5% or ₹ 3.3 trillion of loans are still to be recognized as NPA or restructured assets, suggesting that the actual ratio of impaired assets of India’s banking sector is over 16%.

“We estimate that another 4.5% of loans are stressed (with a large share from the power sector) and therefore expectations of a turn in asset quality cycle are premature,” wrote Ashish Gupta and other analysts of Credit Suisse in the aforementioned report.

The overhang of bad debt has not only hit the profitability of state-owned banks but also affected their ability to grow their loan book. This has serious repercussions on India’s overall credit growth as state-owned banks account for two-third of the overall credit disbursed by scheduled commercial banks. The former RBI governor Raghuram Rajan had argued in a speech earlier this year that “the slowdown in credit growth has been largely because of stress in the public-sector banking and not because of high interest rates”.

Given the scale of the bad loan problem, bankers are likely to remain extremely cautious in granting loans and approving new projects over the next few quarters. This means that a broad-based revival in India’s investment cycle is unlikely to happen anytime soon.