I believe that the NPA story has been well documented and debated.
We all know how ex-Reserve Bank of India Governor Rajan, proactively recognised bad debts in banks and other financial institutions. Under his leadership, for the first time, there was a formal recognition of bad loans. Quickly followed up with the legislation of The Bankruptcy Act, the government showed its commitment to put in place financial infrastructure to deal with this deluge of bad debts.
The logical next step is to sell or restructure these distressed assets through NCLT. Wouldn’t you think this would take place seamlessly? Normally speaking, yes. In an ideal world, banks would write off the loan losses and fresh lending would re-commence once the bad loans are purged from the system.
Let’s stop for a second here: Will this happen in India?
To understand the delay in implementation, we need to know the players, the pressures, and the politics. In India, these translate to the Public sector banks, the Private sector banks, and Government pressure.
While the Public Sector Banks provide about 70% of the loans in the Indian financial market they also contribute the largest amount of Non- Performing Assets. Their current capital and reserves are grossly inadequate to absorb the losses that are in their bad-loans portfolios.
Public Sector Banks’ genesis reveals a heritage that began with the nationalization of Imperial Bank in 1955 which transformed to become the State Bank of India. The next phase came in 1969 when Indira Gandhi nationalized 14 private Banks, followed by another 6 in 1980. Today, these Public Sector Banks are the repository of the bulk of the distressed assets within the banking sector.
The rot had set in decades ago. Although the State Bank of India inherited a skilled and dedicated management cadre, it was unable to resist political pressure when it came to taking a decision whom to lend to and under which terms. Many will recall, State Bank of India’s Managing Director R K Talwar resigning under pressure from Sanjay Gandhi. The pressures exerted by politicians and businessmen has dominated the credit -decisioning in most PSU banks.
And the other player…
Manmohan Singh as the finance minister licensed a number of private banks. These banks have grown like weeds and constitute a mix of Corporate and Retail Lending with a robust deposit base. Without government support, they are conscious that they have to fend for themselves to deal with distressed assets. This has made them more agile and vigilant than their PSU peers.
They require little support to rapidly grow in size and scope. The key to their success has been their independent credit and underwriting capability, adoption of technology and their ability to market their products to retail customers. The challenge for them is to grow to a size where they are equal to their international competitors.
Unlocking the potential of PSUs: Divide and Conquer
The key to the current NPA problem has been:
- Weak underwriting standards,
- Lack of independent credit decision making, and
- Opaque management actions.
Unless this is resolved in a radical manner, new lending will continue to result in ballooning bad credits.
To achieve a sustainable transformation, consider identifying two or three large PSU Banks and strengthen their credit underwriting capabilities. There is abundant talent available in India to provide the leadership.
Eliminate undue political pressure and make the management remuneration in line with private banks. This will encourage the Banks to lend in an ethical and rule-based manner while attracting top class talent.
Adoption of Technology is already underway in PSU Banks and can be used to build the necessary transparency required to manage credit growth reflecting international parameters. The recapitalization Bonds to be issued should also go to these Banks.
The remaining PSU Banks should transfer their healthy assets to the above large PSU Banks. They should not be permitted to lend but must focus only on the resolution of their Bad Loans. As they work through this we will find that their balance sheets will start shrinking. It is likely that their deposits will also move to other Banks. The possibility of merging all these unviable PSU Banks into one Bad Bank also exists.
The tough decisions to be also considered are: closure of their Branches, dealing with the redundant staff via Voluntary Retirement Schemes and sale of all their assets including any unhealthy assets which can be sold off. There will be some capital required to make up the difference between the actual losses and the remaining capital of the Bad Bank. At least a framework emerges which will result in solving this problem over a three to five year period.
What about Non-Banking Finance Companies?
These have been long ignored both by regulators as well as the capital markets. Most NBFCs do not take deposits which makes their funding cost higher than Banks. This forces them to seek riskier loans which enable them to get higher returns. This structural design has resulted in numerous large NBFCs getting into credit problems and facing closure. Interestingly, NBFCs actually play a critical role in delivering credit to the less creditworthy.
With demand from first-time borrowers – both SMEs and individuals – increasingly NBFCs will have the market to grow rapidly.
They are largely privately owned, many listed on the stock market and the better run entities outstrip the Private Banks in terms of growth. The key risk they need to manage is their cost structure and the quality of credit delivered.
This segment is pivotal in providing credit where Banks fear to tread.
Fintech companies a variant to the NBFC story
By integrating customer information online and using surrogates to monitor the flow of sales Fintech companies are nimble and quick in terms of their capability to lend to SME’s and Individuals, currently unable to formally borrow. The Fintech companies could tie up with large Banks and NBFCs could become a force multiplier for the economy.
Quo Vadis
PSU Banks are the largest component of the Banking mosaic today. They are unhealthy and have to undergo a detox that revives their well-being through deep cleansing, nips and tucks, splicing and dicing. The methodology to repair their capital structures via recapitalization bonds has been enunciated but will need a drastic facelift of the credit delivery system and elimination of errant entities.
And the Award goes to…
The Private Banks and NBFCs who are willing and ready to step to meet the credit requirements of the economy.
About the Author
Tushar is the founder Chairman of ATS Services Private Ltd, and has been a banker for over two decades.