Opinion

Why NPAs pile up

Bala Venkatesh | Updated on January 11, 2018 Published on May 09, 2017

BL10_THINK2_DC

Blame it on inadequate credit risk assessment

As a veteran in the global banking and capital markets space, I despair at the ongoing saga of NPAs and their ensuing impact on capital adequacy and balance sheet strength and, of course, the latest ordinance. I see various experts’ suggestions, including from the Ministry of Finance and from the Chief Economic Advisor, on matters ranging from strict operating guidelines for banks’ management, to creation of a “bad” bank entity that would absorb all the NPAs, thereby lowering the capital requirements of the public sector banks. Further, the RBI too has come out with guidelines on how it would evaluate bank performance — this list goes on.

The main issue is that banks are just one part of a larger ecosystem characterised by the lack of a bond market, inadequate credit risk assessment tools and high interest rates for domestic borrowers. Let me elaborate with some simple examples. Sometime ago, our US-based firm received enquiries for overseas loans; in at least three instances our initial analysis and stress-tests suggested they were non-viable even at lower coupon rates. These three companies subsequently informed us that they had been able to get domestic banks to underwrite loans, a matter that surprised us. About two or three years later, all of them are in default status.

The reason why the overall banking system underwrites and pumps more questionable loans is simple; very poor underwriting standards coupled with a lack of execution experience and poor governance standards. Public sector banks work off standard underwriting guidelines for lending, with land, equipment and other personal assets of borrowers as typical collateral. What banks lack is the depth of knowledge and assessment tools that, say, a rating agency that does corporate bond analysis has — reviewing companies’ operating capabilities and performance, not merely the debt servicing cover.

Further, the inability to convert the debt into some form of equity, with voting rights hinders banks’ ability to achieve a financial turnaround of the companies they lend to.

In the absence of a sophisticated bond market, ventures across all industries and credit applications go through the same screening process. And when loans approach NPA status, the first mode of action is to restructure the loan — all that this accomplishes is to postpone the problem at hand. To make matters worse, very few companies hire investment bankers for their expertise in optimising the capital structure of a firm and in seeking the right sources of capital. Instead, companies and promoters see themselves as self-experts in corporate finance and reduce investment bankers to the role of funding brokers.

In the US, we have seen first-hand or handled portfolio turnarounds where profitability has increased 15-20 fold, where bank balance sheet risks have been optimised through a combination of financial risk and credit risk frameworks and rigorous balancing with growth targets established by bank CEOs. In India, the first step would be to scale down lending, rigorously analyse and segment the borrower portfolio with actionable steps, cure the current pipeline and then template from historical performance all future lending activity. A larger objective for the finance ministry would be to bring this same rigour to other channels of capital and funding that are being created through specialised funds.

The writer is a US-based banking and capital markets expert

Published on May 09, 2017

A letter from the Editor


Dear Readers,

The coronavirus crisis has changed the world completely in the last few months. All of us have been locked into our homes, economic activity has come to a near standstill. Everyone has been impacted.

Including your favourite business and financial newspaper. Our printing and distribution chains have been severely disrupted across the country, leaving readers without access to newspapers. Newspaper delivery agents have also been unable to service their customers because of multiple restrictions.

In these difficult times, we, at BusinessLine have been working continuously every day so that you are informed about all the developments – whether on the pandemic, on policy responses, or the impact on the world of business and finance. Our team has been working round the clock to keep track of developments so that you – the reader – gets accurate information and actionable insights so that you can protect your jobs, businesses, finances and investments.

We are trying our best to ensure the newspaper reaches your hands every day. We have also ensured that even if your paper is not delivered, you can access BusinessLine in the e-paper format – just as it appears in print. Our website and apps too, are updated every minute, so that you can access the information you want anywhere, anytime.

But all this comes at a heavy cost. As you are aware, the lockdowns have wiped out almost all our entire revenue stream. Sustaining our quality journalism has become extremely challenging. That we have managed so far is thanks to your support. I thank all our subscribers – print and digital – for your support.

I appeal to all or readers to help us navigate these challenging times and help sustain one of the truly independent and credible voices in the world of Indian journalism. Doing so is easy. You can help us enormously simply by subscribing to our digital or e-paper editions. We offer several affordable subscription plans for our website, which includes Portfolio, our investment advisory section that offers rich investment advice from our highly qualified, in-house Research Bureau, the only such team in the Indian newspaper industry.

A little help from you can make a huge difference to the cause of quality journalism!

Support Quality Journalism
This article is closed for comments.
Please Email the Editor
You have read 1 out of 3 free articles for this week. For full access, please subscribe and get unlimited access to all sections.