NPAs are a mess, but not a lost cause

During the mid-2000s boom, public sector banks were encouraged to lend for infrastructure to fulfil ambitious government targets. Development finance institutions had been closed but corporate bond markets had not developed. Despite financing with shorter-term deposits, banks were expected to be able to pass on their long-term loans using new financial structures. PSBs themselves thought growth would make the projects financed profitable. They were further pushed to support the coordinated stimulus following the global financial crisis of 2008. Debt-equity and prudential norms were relaxed for infrastructure.

But growth collapsed in 2011 after an initial V shaped recovery. The current account deficit widened after excess macroeconomic stimulus and high oil prices. Capital was flowing out. Continuing high food price-driven inflation contributed to macroeconomic instability necessitating fiscal-monetary tightening that reduced industrial demand.

Problems in infrastructure loans started before the demand slowdown, however, with delays in land acquisition and environment clearance. Later in 2010, corruption scandals erupted. Escalating property values triggered insider-grab and push-back from society. Policy paralysis worsened, making infrastructure projects unviable.

Possibly corrupt big borrowers made the Government reluctant to rescue the banks it owned, although it had influenced choices that turned out badly. As part of its Indradhanush restructuring plan it decided to provide only limited amounts conditional on improvements in governance.

In the late nineties, much higher NPA ratios were successfully reduced. One-time forbearance and asset classification benefits allowed restructuring borrower debt. Regulatory innovations, negotiated settlements, as well as growth recovery and booming real estate contributed. This time, however, repeated external shocks and conservative macroeconomic policy worked against the initial forbearance.

Stressed assets need to be recognised and capital provided for them; impaired assets must be resolved, recycled to new ownership, and revived; balance sheets have to be cleaned through capital infusion or conservation so banks can lend again.

Since the Indian resolution framework was poor, the Reserve Bank of India introduced new restructuring schemes. For example, banks were allowed to convert loans to equity, and bifurcate stressed account debt into sustainable and unsustainable portions. But rigid conditions as well as missing skills and market-depth made the schemes ineffective. For example, the short restructuring window implied NPAs were only postponed.

The bar of 50 per cent sustainable debt was too high. There were too few asset restructuring companies or potential owners with capital.

Moreover, PSB incentives are distorted. Since they are subject to CVC or CBI investigation, inaction is rewarded. Haircuts arising out of restructuring could be questioned, and protracted legal battles are required for recovering promoter-dues.

Since bankers aim to protect the net present value of the loan, not the recovery from the borrower, credit given was inadequate.

Recovery was taking too long, and loan and deposit growth in burdened PSBs was the slowest. The RBI, therefore, imposed an asset quality review in 2015.

But recognition and provisioning without capital infusion only made the problem more explicit without solving it. NPAs jumped sharply in 2016.

The considerable stigma NPAs carry worked against the regulatory objective to get banks to restart lending. They encouraged cosmetic rather than viable loans, e constraining borrowers’ fund-raising, and hurting their business prospects. Resolution worsened.

The Government and regulators were focused on structural reform, but this takes time. Sale of bad loans to Asset Reconstruction Companies fell from about ₹50,000 crore over 2013-15 to ₹15,000 crore in 2016-17 when the Insolvency and Bankruptcy Code had been passed, but its supporting infrastructure had yet to be created.

Delays increased debt. High interest rates, low revenue growth, and absence of fresh equity meant double-digit growth in corporate debt over 2011-2015. Loans rolled over to cover interest payments added to debt; smaller firms, especially, were less able to service their interest burden.

The role of external shocks weakens the argument for closing down PSBs. But they must show signs of helping themselves, and their incentives improving.

Pragmatic contextual reform that identifies and removes obstacles to resolution, acting on a number of reinforcing fronts, is more likely to succeed. Apart from cleaning balance sheets, assets have to be revived since their potential value is large under severe infrastructure constraints. A sector-specific focus is required since, unlike the late 90s, NPAs are concentrated in a few big cases. There are large infrastructure projects with little owner-equity. If new private sector owners cannot be found, the Government has to take up ownership pending future disposal when asset values revive. This could be through a new type of development bank which deeper markets can now support.

Since multiple bank lenders are normally involved, talks have progressed and in many cases agreement is in sight. Firms have also been making asset sales. But to avoid standoffs such as in joint lender forums, a committee that protects individual decision-takers’ needs to include independent professionals and rating agencies to assess sustainability and haircuts.

Reducing the Government’s bank share-holding to below 50 per cent could rescue banks from audit by CAG officials whose limited understanding of commerce means they do not make a distinction between corrupt and erroneous decisions. If asset sales or capital infusion is difficult, capital can be conserved in other ways, for example, through mergers, but only where these are indicated on economic synergy.

Current restructuring schemes could operate with more flexibility. Adequate provisions are necessary to withstand analyst scrutiny and allow debt to be sold at fair market value permitting sustainable borrower-balance-sheet restructuring. But if a firm is adequately recapitalised, and there is full disclosure, NPAs could be renamed and classified as a subset of standard assets with lower or staggered provisioning.

In the longer-run, broader governance reforms can strengthen PSB boards, improving accountability and skills and penalising decision-making delays, while diversity is maintained, and specialisation encouraged.

If markets, banks, government, regulators and monetary-fiscal policy flexibility work together, the problems are not insurmountable. Persistent excess capacity suggests that more than corporate debt, lack of demand constrains industrial growth.

The author is a professor of economics at the Indira Gandhi Institute of Development Research, Mumbai

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