Friday, January 27, 2017

Why Did NPAs rise so sharply in 2016?

In the previous article we saw that the year 2016 saw a tremendous rise in NPAs across Banks in India and also saw the outstanding NPA’s on a per bank basis. With those numbers in the background, it is obvious that the Banking Industry in India is on the verge of a major crisis. But, the more important question is, Why or How did this happen?

How did this NPA Story Come About?

In just the first 2 quarters of 2016, nearly 2 lakh crores worth of NPAs were declared by banks. The interesting question here is, how come Banks did not disclose these NPA’s all these years and why are they doing it all of a sudden?

The RBI set a target of March 2017 for all Banks to clean up their balance sheets and disclose the actual value of bad loans. So, the banking system that had a tendency of hiding bad loans and show a healthier than real figures to the investors, had to perform a clean-up and slowly start declaring the true picture. Take any bank, they can’t just say in Feb or March of 2017 that 10,000 crores is their NPA while the RBI released this deadline more than a year back - Right?

How did Banks Get Away with Declaring Bad Loans?

When a loan is in a restructured asset category, it isn’t considered a Bad Loan or NPA yet. Banks happily pushed loans at the first sight of trouble into this restructured loans basket and retained them as regular assets. Since the loan isn’t declared an NPA, the very same people could continue to borrow every more from the same banks or other banks because the borrower isn’t tagged as a defaulter yet.

Why Did RBI give this deadline?

NPAs have always been a point of contention between RBI and the Banks in general. If left unattended, the NPAs could potentially drive the Indian Economy into a bottomless pit from which it cannot recover. The RBI withdrew regulatory forbearance on restructured loans, making it mandatory for banks to make provisions on a restructured loan at par with a bad loan. This means, the banks have to set aside 15% of the loan amount as provisions even if the loan is being restructured. Earlier provisions were only required to be made for NPAs.

Previously if a 100 crore loan is not receiving interested payments for 90 days, the banks had two choices – declare 100 crore as an NPA and mark the borrower as a defaulter. This would of course look bad on the banks balance sheet. So, they mark this 100 crore as a “To be Restructured” loan which technically isn’t an NPA yet and hence delayed adding this 100 crores to the NPA bucket. By doing this clever trick, banks kept adding more and more loans into this restructuring model and avoided adding them as NPA. When RBI declared that provisions need to be made even for restructured loans, banks don't have any incentive to keeping loans in the restructuring bucket. Since the loans aren’t earning any interest, they might as well mark them as an NPA and move on.

What Caused this Accumulation of Bad Loans with Banks?

Take Indian overseas bank & UCO as example, nearly 20% of their loans fall in the NPA category. Still, they are functioning well with no one taking any flak for this scenario. Things are going on per usual because they know that when the bank is in trouble, the Government will Bail them out because at the end of the day, the Indian Government owns these PSU Banks – plain and simple.

Most PSU Banks are like the puppets of the ruling government. The Chairmen have no choice but to listen to their bosses in the Government. In order to show quantity, quality gets compromised. PSU Banks have indulged in careless lending and even if they want to scrutinize any application or initiate recovery proceedings against a defaulter, there is political intervention which results in the bank moving the loan into the restructuring bucket.

In one of my earlier articles on the kingfisher Vijay Mallya fiasco, a friend of mine had raised a question about the multiple times the PSU Banks allowed the restructuring of loans taken by Vijay Mallya without any collateral. More importantly, they allowed further loans even though hundreds of crores worth of unpaid loans existed already.

Do you think a private bank would’ve allowed something like this?

When compared to Government Run Banks, Private Banks indulge in a more thorough evaluation or due-diligence before sanctioning a loan. They also monitor borrowers post the loan disbursement much better in comparison to PSU banks. To top it all off, they initiate recovery proceeds when a loan becomes an NPA while PSU banks get pressure to restructure loans instead of marking the borrower as a defaulter.

Have all NPA’s come out already?

I don't think so. NPAs are coming out in truckloads and this scenario will most likely continue in the coming months leading up to the deadline of March 2017.

Some Last Words:

In order for banks to keep aside cash provisions against their bad loans, thousands of crores worth of money would need to be infused into the banking system by the government. As I had mentioned in my earlier article on Demonetization, willingly or not, citizens have deposited nearly 14 lakh crores worth of old notes into the banking system. So, banks have enough cash to meet these provisioning needs but this is more like a temporary fix to a big problem.

Hopefully the RBI and Banks clean up their act and avert a catastrophe that has just been delayed and could happen very quickly unless otherwise…

What do you think about this situation? Please sound off in the comments section.

Disclaimer: All statistics were taken from the internet and the author does not guarantee the accuracy of the same or assume any liability owing to them being incorrect. This is not a politically motivated post and hence please avoid comments supporting or blaming any political party in this blog.

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