System alert

It would be alarmist to suggest that the crisis at United Bank of India, where escalating bad loans have raised questions of viability, poses a systemic risk to Indian banking. With just a 1 per cent share in total deposits, the bank is a small regional player. And its non-performing assets have arisen, not from large corporate borrowers as for most other banks, but from minuscule sub-₹10 lakh loans extended to farmers and small enterprises. The NPAs, at 10.8 per cent of loans reported by the bank, are also exceptionally high, at twice the level for other public sector banks. The problems have also been known for some time. Statutory auditors have been re-examining the bank’s books since last year and RBI had ordered a forensic audit after it reported large losses in the September 2013 quarter.

But the prospect of United Bank defaulting on its subordinated debt and falling short of capital still needs to be viewed seriously both by RBI and the government. Any whiff of trouble at a public sector bank shakes depositor confidence in the entire banking system. How the government and RBI deal with this case will also set a precedent for other public sector banks which are in dire need of capital, albeit for different reasons. Basel III norms, which became effective from April 2013, are set to impose onerous obligations on banks over the next couple of years. Rising NPAs at United Bank have seen its Tier I capital adequacy ratio falling below the statutory requirement of 6.5 per cent. While no other public sector bank is today in the same boat as United Bank, there are a few (for instance, Union Bank, Central Bank, UCO Bank and Dena Bank) whose ratios are way below the comfort level of 8 per cent. A rapid rise in their NPAs could push them to the brink.

As for United Bank, while some deterioration in asset quality is expected during a downturn, the problems that have come to light in the lending practices and NPA detection systems raise questions about its approach to the business. If the problem as the bank claims lies not so much with bad loans but ‘faulty software’, then how is it that the same software has not thrown up similar ‘deficiencies’ when deployed in other Indian banks? The RBI has been quite right in repeatedly pressuring public sector banks to come clean with their NPAs. It is good that the regulator’s new rules asking banks to put early-warning systems in place to detect slippages ahead of the 90-day cut-off, share information between themselves and take joint action against defaulting borrowers, will come into effect this April. However, this episode also highlights that computer-based systems alone cannot ensure good lending practices. Enforcing greater accountability on the top managements of public sector banks for massive slippages is also necessary. Right now, the short tenures of 1-3 years for public sector bank chiefs discourages them from taking prompt remedial action. Re-examining the manner in which they are appointed may also be key to preventing a repeat of NPA scares like this one.

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