Dr. Rangarajan’s NPA Diagnosis

A recent article, co authored by Dr. Rangarajan the eminent economist and former governor of the RBI, speaks about the causes of NPAs and preventing their pile up.

The NPA crisis continues to plague India’s banking/finance industry and is a drag on its economy. While its roots lie in the 2008 economic meltdown and the ensuing frenzy of reckless, corrupt and crony bank loans, between 2008 to 2013, the covid crisis lockdown, is now building up another massive round of NPAs in banks. All attempts and initiatives to resolve the NPA crisis in the past decade, have failed to resolve it and improve the condition of Indian banks. These initiatives have included restructuring under CDR/SDR/S4A, ARCs, PCA, IBC, bank mergers, recapitalisation, moratorium and now the set up of a bad bank, which maybe the ultimate initiative.

If we go back to the economic meltdown of 2008, which had caused a huge global banking crisis, particularly in the Western nations, we note that they have handled their then NPAs much better, such that, as per the latest available figures from the World Bank, the bank NPAs in USA are a mere 0.9% of their loans, in UK they are at 1.1% of the loans, in Sweden/Switzerland the figure is a paltry 0.6%, Norway is at 0.8%, Germany at 1.1% and France at 2.5%. Even comparable economies have fared much better than India, with the NPAs being at 3.1% in Brazil, 2.4% in Indonesia, 2.1% in Mexico, 3.9% in South Africa and 1.5% in Malaysia, with Russia being an exception at 9.3%. While the figure of bad debts of banks is reported to be at 1.86% in the case of China, experts say that the actual figure could be four to five times this official figure, which means that Chinese banks too are in a serious mess, but are hiding their reality.

If India wishes to revive its economy and record rapid growth, then it needs to resolve the NPA crisis and strengthen its banks. Banking support is a must to attain durable growth, which the NPA stricken Indian banks, have been reluctant and unable to provide. The Modi government has failed to resolve the NPA crisis, primarily because the efforts to do so, have been patchy and devoid of an overall and defined strategy, and have lacked confidence. To us it appears that the government and the RBI, have perhaps failed to truly understand and appreciate the cause of the NPA crisis and have thus failed to formulate a suitable strategy to resolve it.

A recent article, co authored by Dr. Rangarajan the eminent economist and former governor of the RBI, speaks about the causes of NPAs and preventing their pile up. The article points out with concern, that as per the latest FSR of the RBI, the NPAs which had fallen to 7.5% of the total bank advances as at 31.3.21, mainly due to the huge write off of bad loans by banks, are expected to rise to 11.2% by March 2022, which is surprisingly less than the RBI’s own earlier estimate of upto 14.8%, despite there being no improvement in India’s banking economy. Dr. Rangarajan notes that though large advances have contributed to 77.9% of these bad loans, however, with the severe stress in the MSME sector, its contribution in the NPA pile, is likely to go up. The authors then discuss the causes for the build up of the giant mountain of NPAs in India :-

1. India has a weak and dilatory eco system for the recovery/settlement of bank loans, despite the introduction of the IBC, which explains why cases are settled in the NCLT at even 95% haircuts and the total losses/write offs of banks due to this, have been to the tune of Rs. 4 lakh cr., in the past 4-5 years.
2. India has witnessed bouts of excessive credit, as between 2007 to 2013, and then bouts of credit declines as we see now, which the authors say, have harmed the bankers, lenders and the overall system, which needs to be avoided. It is due to this, that even after considering genuine business failures; it is excessive lending, lax credit standards, poor monitoring, diversion/siphoning of funds, malfeasance and frauds, that have caused the high level of NPAs.
3. It is evident from several audit/investigation reports that banks need to improve their credit appraisal techniques and processes and strengthen the banking system. While sanctions and approvals have often been weak/incompetent, it is the weak and patchy monitoring system thereafter, which has let wilful frauds of lakhs of crores take place. Information flow from the borrower is often scanty, delayed and unreliable and despite having 20 monitoring tools, the bankers fail to connect the dots.
4. Despite the SMA classification, early warning signals, which can be easily picked up by the bankers, are yet not picked up.
5. Banks need a better supervision that distinguishes between secular/cyclical decline.
6. Banks need much better and responsible governance, with a key role being played by their independent directors, whose performance must be appraised by the authorities.
7. While bank boards cannot be responsible for each and every credit decision failure unless there is malfeasance, however the massive build up of NPAs is a reflection of major fault lines in business strategy, risk, management strategy, capital management, failure of tactical/strategic issues etc.
8. Since the government is the owner of PSBs, the DFS is an interested party and should thus issue only the broad policy guidelines and should refrain from issuing borrower specific advisories. Unless this principle is adhered to in letter/spirit, the banks cannot be held responsible for their performance.
9. Banks are not good at infrastructure funding, for which DFIs are needed.

In order to resolve the crisis, the way forward according to Dr. Rangarajan :-

1. The banks, the RBI and the government, are all responsible to minimise the probability of bank loan default.
2. Appraisal and monitoring techniques need to be revisited/reset and skills need to be upgraded.
3. The RBI must identify/prevent excess lending and credit concentration.
4. The banks must distinguish between cyclical/secular declines in industry and choose forbearance accordingly.
5. Boards need to identify/mitigate strategic risks and mitigate exuberance.
6. The government as the owner, needs to redefine its engagement with PSBs and give no customer specific advisory.
7. The government and the RBI need to strengthen the entire legal eco system, including the institution of RPs, who have played a dubious role.