What’s all the fuss about?

Reserve Bank Deputy Governor K.C. Chakrabarty recently said that public sector banks had only themselves to blame for their rising non-performing assets (NPAs).

Chakrabarty made a detailed presentation which showed that PSBs accounted for a disproportionately high and increasing burden of NPAs in recent years. In 2009, PSBs accounted for 75 per cent of the credit and 65 per cent of the total NPAs of the banking system.

However in 2013, their share in total NPAs increased to 86 per cent whereas their share in total credit has remained the same.

The deputy governor tried to counter some popular perceptions on the relatively higher NPAs of PSBs. One of them is that NPAs are relatively high in priority sector lending segments compared with the rest; since PSBs shoulder a higher burden of such lending their NPA levels are relatively higher.

Chakrabarty used data to show that GNPA (gross NPA) ratios are higher for non-priority rather than priority sector lending in the last three years up to 2012-13.

Another perception attributes higher NPAs to the economic slowdown.

Chakrabarty laboured hard to counter this. Had economic slowdown been the reason, the NPA percentages should have increased across bank groups, he argued. However, the NPA ratios of PSBs are worse than that of new private banks (NPBs).

He attributed the relatively higher increase in NPAs of PSBs in the last three years to poor credit management.

Contrary view

Do credit management capabilities, which include loan appraisal, monitoring and recovery, really differ widely between public sector banks and new private banks?

We find evidence contrary to such a view. If Chakrabarty’s contention is indeed correct, the NPAs of PSBs should have been consistently higher than new private banks.

However, during 2008-2010, new private banks had relatively much higher NPAs compared to PSBs. Only in the last three years did the NPA percentages come down for the former and go up for the latter. If the increase in NPAs is due to poor credit appraisal skills, it doesn’t explain how NPAs declined from 2004 onwards when the credit growth in PSBs was robust.

The NPAs of PSBs declined from 9.4 per cent of gross advances in 2003 to 2.1 per cent in 2009.

The main reason for the decline in NPAs of PSBs is perhaps the excellent performance of the Indian economy during 2004-08. However, when growth fell post the global financial meltdown, the impact was reflected in the rise in NPAs of PSBs from 2010 onwards.

Point overlooked

But to argue from Chakrabarty’s point of view, if growth whittled down NPAs, surely a fall in growth should have seen a rise in NPAs across all banks. How is it that only the PSBs reported higher NPAs?

This can be explained by the fact that NPAs lag aggressive credit growth, a point completely missed in the debate.

In 2006 and 2007, credit growth in new private banks grew by 50 and 40 per cent, respectively, compared to the system’s credit growth rate of 32 and 31 per cent, respectively. The gross NPA percentages for NPBs increased from 1.7 per cent and 1.9 per cent, respectively, in 2006 and 2007, to 2.5 per cent and 3.1 per cent, respectively, in 2008 and 2009.

The increase in NPA in NPBs in 2008 and 2009 can be attributed to strong credit growth in 2006 and 2007, the lag effect.

The lag effect becomes more pronounced in a slower growth environment as is borne out by the experience of PSBs. Credit growth for PSBs during 2006-2009 was 29.5, 30.2, 24.8 and 25.7 per cent, respectively.

The change

The NPA of PSBs started increasing from 2010 onwards, but more sharply during 2012 and 2013.

The reasons could be: infrastructure loans going bad and the mandate to migrate to the system-driven tracking of NPAs from 2010 onwards, coupled with growth slowdown.

Likewise, the better NPA figures of new private banks can be attributed more to their diversion of credit portfolio towards the retail sector than any other factor.

Aggressively writing off NPAs in 2009 and 2010 is another factor which helped these banks report better NPA numbers in the subsequent years. The NPBs wrote off 48.5 per cent of their opening gross NPAs both in 2009 and 2010, virtually all their NPAs.

So possibly, the decline in the NPA in NPBs is due to cleaning of their balance-sheet.

Policy Logjam

The impact of the slowdown on Indian banks in general and on PSBs in particular is not appreciated.

It is a fact that high growth during 2006-2008 was largely supported by infrastructure growth. This is also evidenced by credit growth in these sectors. While the NPBs have been conservative in the post-crisis period, the PSBs were supportive of the government’s attempt to sustain growth at higher levels by lending to infrastructure.

Projects floated in the post-crisis period couldn’t progress as planned due to delays in land acquisition, environmental clearances and other problems, resulting in time overruns.

The problems were compounded by high interest rates.

Promoters’ cash flow and internal generation of capital suffered as growth declined vis-à-vis what was assumed in the financial projections.

Promoters couldn't fund the cost overrun as the capital markets dried up, compelling banks to restructure loans.

The increase in NPAs in PSBs can, to a great extent, be attributed to slowdown in the economy, evidenced by the increase in NPAs in infrastructure and industry sectors.

It is now well recognised that the slowdown in infrastructure is due to the policy logjam. This has had its impact on the banking sector.

The PSBs have played a major role in financing the economy’s needs, but erred in not anticipating the policy logjam.

The Way Ahead

The moot issue is to create an enabling environment for development and financing of infrastructure.

Unless the government facilitates growth through proper policies and its implementation, PSBs as lenders cannot avoid the pain.

It is feared that criticism from various stakeholders have made bankers adopt a cautious approach, lest they be made accountable to the CVC, the CBI and the regulators.

Stakeholders need to take a more considered view of the situation in which PSBs operate.

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