All’s not well

The Finance Ministry’s mid-year economic review has downplayed the risks to the Indian banking system from persistently bad loans. Drawing attention to the ‘relatively strong’ capital adequacy of Indian banks and comparisons of their gross Non-Performing Asset (GNPA) ratio to global peers, it goes on to suggest that our position vis-à-vis bad loans isn’t all that alarming. But the analysis fails to recognise that the official bad loan figures do not reflect the actual stress in the banking system. Yes, the gross NPA number — cases of borrowers who have already defaulted on their dues — is at about 4.6 per cent of total advances (as of September 2014). As Indian banks have capital amounting to 9.8 per cent of their risk-weighted assets, a back-of-the-envelope calculation would suggest that they have sufficient capital to absorb these losses. But it is not just the existing NPAs that can shrink a bank’s assets. Restructured loans, where banks unofficially allow large borrowers to delay repayments, will also eat into capital if they turn bad. With this figure at a little over 7 per cent now, the existing capital cushion for banks appears far from comfortable.

Despite the talk of green shoots in the economy, bank asset quality has only worsened in the September quarter. Public sector banks, the biggest contributors to stressed assets, have seen both their NPAs and restructured assets rise. In many instances large slippages into NPAs have come from the restructured loan book. If such slippages continue, it will not be long before inadequate provisions drain the banks of precious capital. For many public sector banks, the total stressed loans are way above 13 per cent, while their core capital ratio is below 8 per cent. They are already stretched very thin on capital adequacy. Given this, the mid-year review’s analysis is in stark contrast to the position staked out by the RBI, which has constantly pressed banks to come clean about bad loans. Only this week, the central bank asked banks to identify and share information on ‘non-cooperative’ borrowers, those who stonewall recovery efforts. By cutting off fresh lines of credit to such borrowers, this move is intended to deter banks from throwing good money after bad.

The report, in its bid to paint a better picture on NPAs, also glosses over differences between Indian and global banks on capital adequacy. US and German banks, for instance, have capital adequacy ratios that are 3 to 5 percentage points higher than ours. The truth is that most global banks, after the 2008 financial crisis, have reduced risky lending, improved their profitability, and strengthened their capital bases. But Indian banks have piled on stressed assets and continued to fund excess capacity creation, thanks to lax credit assessment systems. No doubt, the banking system can be nursed back to health if growth returns. But if Indian banks are to avoid a repeat of their past mistakes, it is necessary that the Centre, and not merely the RBI, acknowledges the gravity of the problem.

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