NPAs (non-performing assets) are part and parcel of a bank’s life. But the level matters. One thing that keeps a bank chairman awake at night is perhaps the growing level of stressed assets in his bank. Higher levels of NPAs adversely impact all stakeholders in a bank.

Recent Trends

The overall deterioration in the gross NPA ratio as recorded in 2011-12 was due to Public Sector Banks (PSBs). And within PSBs, the main culprit was the State Bank Group (SBG).

In the case of SBG, it jumped from 3.4 per cent in 2010-11 to 4.6 per cent in 2011-12. This was a bigger leap compared with the nationalised banks (NBs); in the case of the latter, it increased from 2.1 per cent to 2.8 per cent over the same period.

In the case of both Old Private Banks (OPBs) and New Private Banks (NPBs), and for all PBs, the ratio declined between the two years. In the case of Foreign Banks (FBs) the minor increase can be ignored.

Reasons for increase

The Economic Survey, 2012-13 (paragraph 5.32) identifies the following five as the “main” reasons for the growing NPAs in recent times: (a) switchover to a system-based identification of NPAs by PSBs; (b) current macro-economic situation in the country; (c) increased interest rates in the recent past; (d) lower economic growth; and (e) aggressive lending by banks in the past, especially during good times.

Looking at the above reasons, it would appear that nothing but ‘economic malfunctioning’ led to higher NPAs. There is little to say on system identification of NPAs. All the other four factors are ‘economic’ factors. So, how valid is the ‘economy downturn’ hypothesis?

The RBI Report on Trend and Progress of Banking in India, 2011-12 blamed “the slowdown prevailing in the domestic economy” as the prime cause for increase in NPAs (paragraph 4.29).

In general, there are two broad reasons for any economic occurrence: (a) endogenous and (b) exogenous. While endogenous factors are controllable, exogenous ones are not. By holding the economy responsible for higher NPAs, bankers are evading responsibility for the ‘controllable’ (or exogenous) factors. However, there are ways to deal with exogenous factors.

Project appraisal

If the ‘economy’ has been playing villain, the moot issue is how much importance the credit appraisal team accords to it in its project appraisals. The Indian economy has become more complex today than in the pre-reforms era.

These complexities have to be woven into the techno-economic appraisal of any project.

In the case of project finance stretching over one or more decades, one has to build various economic ‘scenarios’ into their appraisals and also spell out ‘strategies’ to be pressed into action when a particular (adverse) scenario materialises. This is not an easy task.

The only reliable and well-respected document that gives projections for various sectors and the economy, and that too only for five years, is the Plan Document of the Planning Commission. Beyond five years, the appraiser has to base his appraisal on certain assumptions. How realistic are those assumptions? This cannot be said at the time of appraisal.

Therefore, there is a need to craft a system of a ‘rolling plan’ into the project appraisal. At frequent intervals, the assumptions are required to be checked with the emerging environment and revised accordingly. The same holds true for strategies. Is it being done?

By holding the economic environment as the main culprit we are lumping genuine cases of project financing with the bad (or mis-financing) ones.

This should not occur. Accountability for bad decisions would suffer.

The integrity and the financial acumen of the project team should be beyond doubt. The apex credit committee should have the knowledge and experience to distinguish wheat from chaff.

PSBs under the Indian Banks Association (IBA) should lobby with the central bank and the Central or State governments to influence policies so as to alleviate the impact of a bad economic phase. In fact, IBA should be as proactive as its industry counterparts such as the CII, FICCI, Assocham and Nasscom to mould policies in favour of the banking industry.

All major credit proposals should pass under the eyes of the Chief Economist of the bank. This is a practice in all foreign banks. The Chief Economist in foreign banks is a member of the apex credit committee. Is it being done in PSBs? Probably not.

As mentioned earlier, the Economic Survey cites increased interest rates in the recent past as one of the factors for the incidence of higher NPAs. This merits some comment.

Interest rates were increased by the RBI to control inflationary pressures and ensure a smooth transition to an 8-9 per cent growth trajectory.

This objective, which is intertwined with the nation’s economic welfare, cannot be blamed for the rising level of NPAs.

Aggressive lending in good times is another reason mentioned in the Survey for higher NPAs. However, if the project appraisal has been done along the desired lines, with all due diligence, aggressive lending cannot so easily turn into bad debts.

If ‘economy’ were the cause, the incidence of NPAs would have been equally bad for Old Private Banks, New Private Banks and Foreign Banks.

In this context, it is worth quoting RBI Deputy Governor K.C. Chakrabarty who, while delivering an address on Corporate Debt Restructuring, said as follows: “If the reason for the recent increase in restructured accounts is indeed the economic downturn, then it should have been reflected across all bank groups, and not just public sector banks” (RBI Web site).


Hence, it is specious to blame the ‘economy’ for the higher level of NPAs.

If one has to blame anything, it is poor credit appraisal, monitoring and follow-up, besides inadequate lobbying by IBA.

The only other factor identified by the RBI Report is the “inadequate appraisal and monitoring of credit proposals” (paragraph 4.29), which the Survey also endorses (paragraph 5.32).

Last but not least, behind the veil of economic slowdown, many businessmen who are sitting on piles of cash and are actually capable of reviving their businesses, are not doing so. Nor are they repaying their bank debts.

Instead, they are engaging in speculative activities such as purchase of real-estate and precious metals, making it even more difficult to turn the economy around.

(The author is a former senior commercial bank economist.)