Bad debts are a common feature of any business, but in banking they assume special importance mainly due to two reasons — one, loans are their primary business and two, valuation of financial assets is a matter of trust.

Technically, non-performance is a regulatory rather than an accounting concept; in India, NPA norms came into being only in the mid-nineties, post the Narasimham Committee. The current 90 days default benchmark evolved over the years — in 1993, the definition of non-performance was a more liberal four quarters default criterion. Today, most regulators have adopted the more stringent 90-day benchmark.

If, for a moment, we disassociate the issue of fraud or criminality from default, it would be clear that the concept really aims at ensuring that banks report loan values fairly and more importantly, recognise only actual and not fictitious income. These are really the twin objectives of the prudential asset classification norms.

The level of bad loans in the system began sky-rocketing from 2012. While loan books of banks had also undoubtedly grown rapidly, the reasons for the massive spike in bad loans remained unclear because of the lack of transparency in data. This led to much conjecturing on the causes, which ranged from economic downturn impacting key sectors, wilful defaults and even excessive borrowings by corporates that were difficult to service.

Spotlight on infra, steel

But these are broad macro factors while the unit-level data of some of the banks with the largest levels of NPAs is more revealing. From the annual reports and regulatory disclosures of SBI, PNB and BOI, the top three which account for over a third of total NPAs in the system, a common thread is the preponderance of NPAs in infrastructure and steel sectors. At an aggregated level, steel and basic metals accounted for 28 per cent of their NPAs, while infrastructure sector (power, roads and telecom) accounted for 13 per cent. The percentages would be even higher if we add the numbers of other project finance players such as ICICI Bank and IDBI Bank, but the limited point is that this is large enough a proportion to provoke analysis on lines other than fraud or criminality.

Traditionally, these were sectors that were financed by specialised term lending institutions such as IDBI, ICICI and IFCI, which were actually mandated to finance large, capital-intensive industries in the core and infrastructure sectors. To this end, they also enjoyed privileges such as low-cost, long-term sources of borrowing, while their non-bank status ensured a less rigorous regulatory framework. But these institutions don’t exist today. This left a huge vacuum in the project lending space for industry that other commercial banks, mainly public sector, were forced to fill.

These sectors pose unique financing problems for banks. First, they are long gestation projects — power, steel projects take many years to build, implying that lenders cannot expect short-term returns. These projects are ideally suited for riskier equity investment or market sourced debt (as is usually the case in advanced countries) but certainly not for banks, who run a huge asset-liability mismatch with short-term deposits constituting their main resources.

Secondly, infrastructure projects are notoriously unviable in the short and medium term because tariffs can never be set high enough to satisfy investors and lenders, the classic market risk. This is evident from the large number of power sector NPAs with banks or even road projects, where projects failed to achieve projected revenues either due to falling tariffs or simply not being implemented.

These two factors would also explain why restructuring has limited success, because the real issue is of accepting longer forbearance and lower returns, which does not quite go with a 90-day default criterion.

To be fair, the RBI tried to help with several measures, such as the 5-25 scheme and a more liberal NPA dispensation, but they probably did not address the fundamental problem of long term and low returns. Project financing experts speak of 16 types of risks and quite a few are in play currently, such as environmental and political risks, to name only two. Clearly, one lesson that we can draw from the NPA problem is that large project financing should be left to specialised institutions or debt markets. While the current lull in investment climate may mask the urgency, a long-term solution is necessary to avoid a recurrence of the problem.

The writer is an independent consultant

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