by Vivek Kaul
Mallya has since become a poster boy for all that is wrong with Indian banking. A big bad capitalist who has taken on loans from PSBs and is now refusing or not in a position to repay them. Media reports suggest that Mallya owes banks around Rs. 9,091 crore. This includes the initial loan amount, the interest that has accumulated on it due to the lack of repayment from Mallya, and the interest that has accumulated on that interest.
Mallya, though, is a small part of a very big problem, as can be made out from Table 11.2.
Table 11.2: Mallya’s a small fry.
Source: Jayant Sinha, the then Minister of State in the Ministry of Finance, in a written reply to a question in the Lok Sabha, March 11, 2016.
As can be seen from Table 11.2, the Gross Non-Performing Assets (GNPAs), or bad loans of banks in the form of money that they had lent to corporates, has been going up steeply over the last few years. The corporate bad loans have jumped from around Rs. 1 lakh crore to Rs. 2.6 lakh crore over a period of less than four years.
And how do we define GNPAs, or bad loans? As per the Reserve Bank of India: “An asset… becomes non-performing when it ceases to generate income for the bank.” When the corporate borrower stops paying interest and repaying the principal on a loan, the bank typically allows for a grace period of 90 days. After this grace period is over, the bank categorises the loan as a non-performing asset and starts setting aside money (or making provisions) for it. The total sum of such loans forms the gross non-performing assets, or bad loans, of the bank.
For the first year after a loan has been categorised as a non-performing asset, it is referred to as a sub-standard asset. On this loan, 15 per cent of the outstanding loan amount needs to be set aside as a provision.625
At the end of the first year, the loan becomes a doubtful asset. For the first year of being categorised as a doubtful asset, 25 per cent of the outstanding loan amount needs to be set aside as a provision. For the second such year, this jumps up to 50 per cent. And for the third year, 100 per cent of the outstanding loan amount needs to be set aside as a provision. Thereafter, the loan is categorised as a loss asset.626
Getting back to Mallya, his outstanding loans of a little over Rs. 9,000 crore are just a small part of a large problem. It is worth remembering here that a loan being categorised as a gross non-performing asset does not mean that all is lost for the bank when it comes to that particular loan. The bank can recover money from the asset that has been offered as collateral against the loan. Of course, this is not as straightforward as it sounds, and there are problems that come with this. In Mallya’s case, he had also given personal guarantees to banks while taking loans for Kingfisher Airlines.
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Table 11.3(a) shows the deterioration of the state of Indian banks over the past few years. As can be seen, the gross NPAs have increased from around 2.4 per cent of the total loans in March 2010 to around 7.6 per cent of the total loans as on March 2016.
The PSBs have been majorly responsible for this deterioration in performance. The bad loans of PSBs as on March 31, 2016 stood at 9.32 per cent of their total loans. The figure was at 3.8 per cent of the total loans in March 2013. What is also interesting is that between March 31, 2015 and March 31, 2016, there had been a huge jump in the gross non-performing assets of PSBs, in particular, and banks, in general.
Table 11.3(a): Bad loans of banks at the end of each financial year over the past few years.
Source: RBI Financial Stability Reports and Media Reports.
As on March 31, 2016, the bad loans of banks had stood at 7.6 per cent of the loans that they had given out. This figure had stood at 5.1 per cent as on September 30, 2015. It had stood at 4.6 per cent as on March 31, 2015.
This basically means that, between March 2015 and March 2016, the bad loans of banks had gone up by 300 basis points. (One basis point is one hundredth of a per cent.) Between September 2015 and March 2016, the bad loans of banks had gone up by 250 basis points.
What is interesting, nonetheless, is that between September 2012 and March 2015, the bad loans had gone up by only 100 basis points, from 3.6 per cent of the total loans to 4.6 per cent. So what happened during the year 2015-2016 that led to the proportion of bad loans suddenly going up? The simple answer lies in the fact that the Reserve Bank of India (RBI) cracked the whip and decided to carry out an asset quality review of the banks. The RBI asset quality review covered 36 banks (including all PSBs). This review accounted for 93 per cent of the total lending carried out by the scheduled commercial banks.
And this has led to a scenario wherein the banks are finally getting around to recognising bad loans as bad loans, something they were ignoring earlier. So the question is: What was happening earlier?
As of March 2010, the stressed assets of banks had stood at 5.4 per cent of the total loans. What are stressed assets? The stressed assets figure is obtained by adding the total bad loans to the total restructured assets. Over the past few years, the stressed loans ratio of banks has gone up at a rapid rate, as the banks restructured loans at a rapid pace (as can be seen from Table 11.3(a)). A restructured loan essentially implies that the borrower has been given a moratorium for a certain period, during which he does not have to repay the principal amount. In some cases, even the interest need not be paid. In some other cases, the tenure of the loan gets increased. In this chapter, restructured loans have also been referred to as restructured assets.
As can be seen from Table 11.3(a), between March 31, 2010 and March 31, 2015, the gross NPAs of banks went up from 2.4 per cent to 4.6 per cent, i.e., by 220 basis points. During the same period, the stressed assets went up from 5.4 per cent to 11.1 per cent, i.e., by 570 basis points.
Hence, the stressed assets of banks increased at a much faster rate than the bad loans alone. This was basically because of a rapid increase in the restructured assets between March 2010 and March 2015.
When a bank restructures a loan, it does so with the intention of giving the borrower some time so that he can get back to repaying the loan. At least, that is the intention. But what really happened in the Indian case was that banks essentially used the restructuring route to postpone recognising bad loans.
The moment a bank recognises a bad loan, it has to start provisioning for it (i.e., setting aside money for it). This is prudent accounting. As the then RBI Governor, Raghuram Rajan, said in a February 2016 speech:
If the bank wants to pretend that everything is all right with the loan, it can only apply bandaids – for any more drastic action would require NPA classification. Loan classification is merely good accounting…. It is accompanied by provisioning, which ensures the bank sets aside a buffer to absorb likely losses. If the losses do not materialise, the bank can write back provisioning to profits. If the losses do materialise, the bank does not have to suddenly declare a big loss; it can set the losses against the prudential provisions it has made. Thus the bank balance sheet then represents a true and fair picture of the bank’s health, as a bank balance sheet is meant to.
But prudent provisioning means that the profit of the bank comes down in the short term. And no one running a bank wants that. Hence, Indian banks, in particular PSBs, went about restructuring loans and, in the process, managed to postpone the bad loans problem.
An estimate made by CRISIL ratings in a note titled ‘For banks, no respite from bad loans this year’, published in May 2015, suggested that around “40 per cent of [the] assets restructured during 2011-14 [had] slipped into NPAs”.627 This strategy of banks came to be referred to as ‘extend and pretend’. This essentially involved passing off bad loans as restructured loans and, in the process, delaying the process of recognising a bad loan.
In a research note titled ‘A Growing Need for Indian TARP’,xvii Anil Agarwal, Sumeet Kariwala and Subramanian Iyer, analysts at Morgan Stanley, point out: “The current managements’ policy of ‘extend and pretend’ is causing banks to move further into problems.”628 The analysts also said that they expected 65 per cent of th
e restructured loans to turn into bad loans.
What this tells us very clearly is that many loans that banks were restructuring between 2011 and 2015 had already turned into bad loans. The PSBs were primarily the ones doing this because they had many more bad loans to handle in comparison to the private sector banks.
This came to an end after the RBI decided to start the asset quality review. Between September 2015 and March 2016, the bad loans of banks jumped up, and finally, there was some good news for Indian banks. Another massive mess made by the Big Government was finally being brought out into the open.
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The bad loans of Indian banks jumped from 4.6 per cent as of March 2015 to 7.6 per cent of the total loans as of March 2016. Nevertheless, this was good news for the banks. But how can the bad loans of banks going up be good news? It was good news because the banks (particularly PSBs) were finally getting around to recognising the bad loans for what they essentially were.
This becomes clear from looking at the restructured assets of banks. As on March 31, 2016, they fell to 3.9 per cent. In September 2015, they had stood at 6.2 per cent. The overall stressed assets ratio of banks as on March 31, 2016 stood at 11.5 per cent, against 11.3 per cent as on September 30, 2015.
A stressed asset ratio of 11.5 per cent was basically obtained by adding the bad loans of 7.6 per cent to the restructured assets of 3.9 per cent. In September 2015, the restructured assets had stood at 6.2 per cent, whereas the bad loans had stood at 5.1 per cent, leading to a stressed assets ratio of 11.3 per cent.
What this tells us is that, between September 2015 and March 2016, the stressed assets ratio had gone up by just 20 basis points, from 11.3 per cent to 11.5 per cent. Indeed, this was good news for the simple reason that banks were now being forced to recognise bad loans as bad loans, and not pass them of as restructured assets, like they were doing earlier.
Now let’s look at these parameters as applied only to PSBs. The stressed assets ratio of PSBs as on March 31, 2016 had stood at 14.5 per cent. As on September 30, 2015, the ratio had stood at 14.1 per cent. The stressed assets ratio of PSBs is now going up at a slower rate than it was in the past, as can be seen from Table 11.3(b).
Table 11.3(b): The stressed assets ratio of PSBs over the past three years.
Date Ratio (in %)
March 31, 2016 14.5
September 30, 2015 14.1
March 31, 2015 13.5
September 30, 2014 12.9
March 31, 2014 11.7
September 30, 2013 12.3
March 31, 2013 10.9
Source: RBI Financial Stability Reports.
What this means is that even the PSBs are cleaning up their act by recognising more and more bad loans as bad loans. This wasn’t happening in the past. It is now important that they go after the borrowers (especially the larger ones) and recover as much of the loans as they can. The more the loans that they can recover, the lesser will be the capital that the government will have to put into these banks to get them up and running again.
The RBI releases the Financial Stability Report twice a year. The June 2016 report points out that “under the baseline scenario, the gross non-performing assets ratio [bad loans ratio] may rise to 8.5 per cent by March 2017 from 7.6 per cent in March 2016. If the macroscenarios deteriorate in the future, the gross non-performing assets ratio may further increase to 9.3 per cent”. The point is that the worst is still not over for India’s banks.
Also, unlike many other parts of the world, Indian banks have had almost no trouble with their retail borrowers. Their problems are because of large borrowers and, in particular, crony capitalists.
The crony capitalists and the large borrowers have been responsible for a major part of the bad loans of Indian banks. This basically means that banks need to be aggressive about recovering their loans. Furthermore, it’s time that the government, as the owner of the PSBs, start forcing the defaulting promoters to give up their stake in the companies which have defaulted.
Nevertheless, the bigger problem still remains. The bigger problem is the fact that the PSBs continue to remain government owned. The Indian PSBs have ended up in trouble more than a few times before. One of the reasons for this is the politicians forcing these banks to lend to crony capitalists. This is one of the biggest costs of Big Government, one which hasn’t been properly quantified by anyone as yet.
And as long as these banks continue to remain government owned, that risk remains, especially given that it is crony capitalists who ultimately finance the electoral ambitions of India’s politicians.
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It needs to be pointed out here that the central government had already infused Rs. 1.02 lakh crore of capital between 2009 and September 2015 into the PSBs.
Rs. 1.02 lakh crore is clearly a lot of money, and this has been taken away from other important areas that the government could have spent it on. For 2016-2017, the government has budgeted Rs. 25,000 crore to be invested in the PSBs. In fact, Finance Minister Arun Jaitley said in his February 2016 budget speech: “If additional capital is required by these Banks, we will find the resources for doing so. We stand solidly behind these Banks.” This was Jaitley’s way of saying that the government would do whatever it takes to keep these banks going.
The trouble is that this guarantee is going to cost the Indian union a lot of money in the years to come. How much is anybody’s guess, but there are several estimates going around. Estimates made by the Committee to Review Governance of the Boards of Banks in India (better known as the PJ Nayak Committee) suggests that, between January 2014 and March 2018, “PSBs would need Rs. 5.87 lakh crores of tier-I capital”.
Tier-I capital is the core capital of the bank, and consists of its disclosed reserves as well as its equity capital. The Committee further said that “assuming that the Government puts in 60 per cent (though it will be challenging to raise the remaining 40 per cent from the capital markets), the Government would need to invest over Rs. 3.5 lakh crores”.
The government, on the other hand, estimates that “the requirement of extra capital for the next four years up to FY 2019 is likely to be about Rs.1,80,000 crore”. This estimate was made as a part of the Indradhanush reforms that the government unveiled in order to revamp the PSBs. Of this Rs. 1,80,000 crore, the government, as a major owner of these banks, plans to invest Rs. 70,000 crore between 2015-2016 and 2018-2019. The government hopes that the “improvements in capital productivity will enable PSBs to raise the remaining Rs. 1,10,000 crore from the market”.629
Even though the government’s estimate is around 31 per cent of the Nayak Committee’s estimate, it is not a small number by any stretch of imagination. Other than taking away money from more important things, this tendency of the government to keep infusing capital into PSBs builds tremendous moral hazard into the system.
The economist and former Vice-Chairman of the Federal Reserve of the United States, Alan Blinder, writing in After the Music Stopped, says that “the central idea behind moral hazard is that people who are well insured against some risk are less likely to take pains (and incur costs) to avoid it”.630
As Mohamed A El-Erian writes in The Only Game in Town: “[It] is the inclination to take more risk because of the perceived backing of an effective and decisive insurance mechanism.”631
Hence, if the government keeps infusing capital into PSBs and keeps rescuing them whenever they are in trouble, there is no real incentive on the part of the PSBs to run a responsible, viable and profitable business. This is moral hazard at play. It is not surprising that, as of the end of March 2016, the gross non-performing assets of the PSBs stood at 9.32 per cent of their total loans.
The government is keen to hold on to these banks. As the Economic Survey of 2015-2016 pointed out: “The return on assets for most banks is currently less than one-third of the norm of 1 per cent that is considered reasonable. Many, though not all, of the less profitable banks are those with smaller levels of employment.” Despite this, the go
vernment remains obsessed with the idea of owning 27 PSBs. There has been no effort made to sell out of these banks or even shut them down.
Some of the smaller PSBs are very small. And given this, shutting down a few smaller PSBs which are in trouble is not going to make much of a difference, at least not on the employment and lending fronts. Furthermore, no effort has been made to privatise them either.
Given the state that some of these banks are in right now, there is no way the government is going to get a decent price if it considers selling them. Nevertheless, the chances of these banks being turned around by private management are higher than if they are continued to run as they currently are. In such a scenario, the minority stake that the government would continue to hold in these banks would be worth much more than the current majority stake it holds. The point being that the government needs to stop looking at these banks as ‘family silver’.
In fact, the ambition of the government to run 27 PSBs is an excellent example of all that is wrong with Big Government in India. It doesn’t realise that it is a hopeless idea to continue to own and run 27 PSBs. There are more important things that it needs to be concentrating on, but that is not going to happen given the way things have shaped up in India.
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When it comes to bad loans, the lending carried out by banks to corporates/industry is turning out to be a big pain. Take a look at Table 11.3(c), which shows the gross non-performing assets of the State Bank of India (SBI), which happens to be not just the biggest PSB but also the biggest bank in India.
Table 11.3(c) shows us very clearly that State Bank of India’s lending to corporates is primarily responsible for its bad loans. As on March 31, 2016, the total gross NPAs of SBI stood at Rs. 98,173 crore, or 6.5 per cent of the total loans.
Of this, the total NPAs of the corporate sector amounted to Rs. 79,243 crore (large corporate + mid-corporate + SME). This formed 80.7 per cent of the total gross NPAs. The Bank of Baroda, the second largest PSB, also shows a similar trend, with lending to the corporate sector amounting for a major part of its bad loans.632