Deferred distress

The recent India Ratings & Research’s estimate that restructured assets in the banking system will surge by about ₹1 lakh crore over the next five months is indeed cause of concern. Given that close to ₹2 lakh crore of restructured assets were added over the last two years, accumulating half this amount in a matter of five months is alarming. The real worry with bad loans has always been that the official non-performing assets (NPA) figures — where borrowers have defaulted in their payment — do not capture the true extent of the problem. The large amounts of loans that have been restructured in the pretext of extending a ‘lifeline’ to businesses, now pose a serious threat to the health of public sector banks that own the lion’s share of such assets. If the economy continues to languish for a few more quarters, large amount of restructured loans could turn bad and lead to systemic risk.

It is the lapses in prudential norms in state-owned banks that has both created and worsened the problem. With the availability of the restructuring window, banks have classified more than half of their bad loan problem as ‘restructured’ in the last two years, postponing the problem for a few years down the line. Thus public sector banks that have dealt with alarming levels of 14 per cent of bad loans pre-2001, are in a far stickier situation now, looking at potentially large slippages on their restructured loans. Many public sector banks’ bad loans and restructured assets put together are nearly 100 per cent of their net worth and less than a third is provided for. With effect from April 2015, the existing “regulatory forbearance” on restructuring will no longer be available, and such loans will be treated as bad loans. The suggestion that the RBI should throw a line to corporates and banks by extending the restructuring window has no merit; the combination of bad loans and restructured loans, which already exceeds ₹6 lakh crore, will only worsen by extending the leeway.

Until the economy revives and corporates start to generate substantial cash flows, the RBI can help by boosting bank profitability. The long pending demand of banks to earn interest on their deposits with the RBI (cash reserve ratio) can be considered. A 7 per cent interest on such deposits will mean close to ₹25,000 crore of income for banks. This will help banks bring down interest rates on deposits, provide some headroom to lower lending rates, even if the RBI chooses not to ease its policy rates. Also, lending to infrastructure sector without regulatory requirements should not be limited to new projects but extended to existing projects as well. By doing so, the RBI can help banks reduce the cost of funding to infrastructure projects and minimise the need for restructuring such loans. Given that infrastructure is among the top five sectors that contribute to the level of stressed loans, this can slow down the pace of loans restructured within the sector.