TheLeaflet
  • Home
  • About Us
    • Why Leaflet
    • Leaflet Team
  • Constitutional Law
  • Human Rights
  • Culture
    • Book Review
    • Movie Review
    • Poetry
  • Humour
  • Issues
    • Analysis
    • Case update
    • Child’s Rights
    • Civil Law
    • Coronavirus and the Law
    • Criminal Justice System
    • Criminal Law
    • Dalit Rights
    • Editor’s Desk
    • Education
    • Environment
    • Fundamental Rights
    • Gender Rights
    • Governance
    • Health Rights
    • History
    • International Law
    • Judiciary
    • Juvenile Justice
    • Know Your Rights
    • Labour Law
    • Law and Technology
    • Litigation
    • Mental Health
    • Policy
    • Politics
    • Right To Informtion
    • Sexual Offences
    • Social Justice
  • Leaflet Specials
    • Independence Day Special
    • Independence of judiciary
    • Right to Privacy
    • Special Issue: Emergency
    • The legacy of Ruth Ginsburg
    • Triple Talaq
    • Two years since Navtej Johar case
  • Videos
  • Historical Series
  • Contact us
    • Write For Us
    • Careers
No Result
View All Result
  • Home
  • About Us
    • Why Leaflet
    • Leaflet Team
  • Constitutional Law
  • Human Rights
  • Culture
    • Book Review
    • Movie Review
    • Poetry
  • Humour
  • Issues
    • Analysis
    • Case update
    • Child’s Rights
    • Civil Law
    • Coronavirus and the Law
    • Criminal Justice System
    • Criminal Law
    • Dalit Rights
    • Editor’s Desk
    • Education
    • Environment
    • Fundamental Rights
    • Gender Rights
    • Governance
    • Health Rights
    • History
    • International Law
    • Judiciary
    • Juvenile Justice
    • Know Your Rights
    • Labour Law
    • Law and Technology
    • Litigation
    • Mental Health
    • Policy
    • Politics
    • Right To Informtion
    • Sexual Offences
    • Social Justice
  • Leaflet Specials
    • Independence Day Special
    • Independence of judiciary
    • Right to Privacy
    • Special Issue: Emergency
    • The legacy of Ruth Ginsburg
    • Triple Talaq
    • Two years since Navtej Johar case
  • Videos
  • Historical Series
  • Contact us
    • Write For Us
    • Careers
No Result
View All Result
TheLeaflet
No Result
View All Result
in Analysis

NPAs: Prevention Is Better than Cure. But What Are We Doing about It

Sushil PrasadbySushil Prasad
December 9, 2020
in Analysis
NPAs: Prevention Is Better than Cure. But What Are We Doing about It

Bank governance requires urgent reforms in order to fix the problem of Non Performing Assets instead of merely managing the NPA’s, writes SUSHIL PRASAD.

———

The large and increasing levels of non-performing assets (NPAs) of the Indian banking industry, especially of the public sector banks (PSBs), has been dominating headlines for quite some time now and there seems to be no end to this saga.  

Gross NPA to total assets ratio (GNPA ratio), one of the key tools of measuring NPA levels of the Indian banking industry (i.e., their efficiency), stood at about 8.5% at the end of March 2020 (11.3% for PSBs and 4.2% for private banks), and is expected to increase to a level of around 14% by March 2021.

To put these NPA levels in perspective, we need to appreciate that any bank, with a GNPA ratio of, say, over 3%-4%, is essentially making operating losses. 

Incidences of bad loans are essential to the trial and error process required for development and are normal in dynamic financial markets, i.e., some amount of occurrence of NPAs is natural and expected in the banking business. However, the margin of error that banks can tolerate is very low. 

 As JD Von Pischke has very succinctly put, “Experience has shown that bad loans amounting to 3% of loan portfolios can give commercial banks and their government regulators major cause for indigestion.”

To put these NPA levels in perspective, we need to appreciate that any bank, with a GNPA ratio of, say, over 3%-4%, is essentially making operating losses. 

The situation with which we are blissfully living is that some of our public sector banks (PSBs) have NPA levels of over 20%. With abysmal recovery rates most of these NPAs would have to be written off against capital. Therefore, banks with such high NPA levels would effectively have negative networth if the promoter, the government of India, had not infused fresh capital at regular intervals (Rs4 lakh crore over the past 10 years). 

This is being funded by the poor Indian taxpayer who, in return, gets indifferent service, negative real interest rates on deposits, higher levels of interest rates on loans and lower levels of economic growth compared to the potential. 

Incidences of bad loans are essential to the trial and error process required for development and are normal in dynamic financial markets, i.e., some amount of occurrence of NPAs is natural and expected in the banking business. However, the margin of error that banks can tolerate is very low. 

To manage and contain the NPA problem, academicians, policy-makers, the Reserve Bank of India (RBI) and the government have come up with a virtual alphabet soup of schemes over the past 40 years. This includes, Sick Industrial Companies Act (SICA), the board for industrial and financial reconstruction (BIFR), the securitisation and reconstruction of financial assets and enforcement of security interest (SARFAESI), debts recovery tribunals (DRTs), corporate debt restructuring (CDR), strategic debt restructuring (SDR), 5/25 mechanism, joint lenders’ forum (JLF), scheme for sustainable structuring of stressed assets (S4A)—to name some, the Insolvency & Bankruptcy Code (IBC) being the latest ‘magic wand’ to address this gargantuan problem. 

The moot point is that all of them aim at resolving NPAs and not one of them is designed to ensure that the incidences of NPAs are controlled. 

One of the key functions of banks is to continuously produce good quality loans & advances or loans, which have a low probability of default. From this perspective, the incidence of high and growing levels of NPAs in the Indian banking system is akin to a manufacturing organisation making a larger than acceptable level of defective products.

The moot point is that all of them aim at resolving NPAs and not one of them is designed to ensure that the incidences of NPAs are controlled. 

A manufacturing organisation sets up quality control systems to ensure production of goods of consistently high quality. This analogy suggests that there is something wrong in the systems and processes for appraisal, structuring, sanction and monitoring of loans by our banking system. 

The production process used by banks to ensure that consistently good quality loans are made consists of making a series of judgements or decisions for which banks need to have a governance mechanism that engenders independent and professional decision making and an appropriate conceptual framework for lending.

Both these aspects have been severely hit by the pervasive micro-management practised by the department of financial services (DOFS) and RBI. Having nearly 70% of our banking system in the public sector also does not help. 

The vitality of our financial markets has got sapped due to the virtual absence of creativity and innovation on account of lack of competition. 

The closed, one-size-fits-all framework for recruitment, promotions, pay-scales, to the identical core banking system has left little room for experimentation and innovation, or growth. After all, only open systems can hope to achieve negative entropy!

The vitality of our financial markets has got sapped due to the virtual absence of creativity and innovation on account of lack of competition. 

Governance of our banks has been going from bad to worse over the past few decades. 

For the political class, irrespective of persuasion or ideology, PSBs are meant to be milked – for giving cheap loans (before waiving them off) to favoured constituents, which keeps the controllers of the mass vote market in good humour, for enabling generous funding of the friendly corporate sector which, in turn, lubricates the political machinery through donations (now made easier and opaque through use of electoral bonds), and for pump-priming the economy in the absence of sufficient fiscal space.

Public sector does not automatically mean lack of professionalism and accountability, provided governance systems enable and nurture it. The pervasive interference of DOFS and MoF (Ministry of Finance), with its natural consequence of politicisation of decision making and development of highly patronising relationship between bank management and government bureaucrats, needs to be addressed forthwith.

In the process, professionalism in our PSBs is as good as dead with PSB boards not considered competent enough to select their top managers, leave alone other professional and competent members on the board.

 The conceptual framework under which most lending is done in India evolved when banks primarily lent for trade. This ‘need based lending’ limits assessment extensively evolved as a credit rationing device and not as a credit risk assessment mechanism. Consequently, both debt and equity risk are embedded in the loan portfolios of our banks, while the pricing is wholly linked to debt risk. This naturally leads to a sub-optimally priced loan portfolio, in other words, steady occurrence of NPAs.

 There are other contributing factors too. For example, the amount of time and effort spent on ensuring end-use of borrowed funds. One of the prime reasons that money (or credit) is useful is because of its property of fungibility. This makes ensuring ‘end-use’ very tricky.

For the political class, irrespective of persuasion or ideology, PSBs are meant to be milked – for giving cheap loans (before waiving them off) to favoured constituents, which keeps the controllers of the mass vote market in good humour, for enabling generous funding of the friendly corporate sector which, in turn, lubricates the political machinery through donations (now made easier and opaque through use of electoral bonds), and for pump-priming the economy in the absence of sufficient fiscal space.

 The strongly held belief that, since bank liabilities are short term, they should make only short-term loans is also misguided and illogical. First, this hides the fact that managing and profiting from maturity mismatches between deposits and advances is a prime function of financial intermediaries. 

 Second, most borrowers need both the long-term and short-term borrowings to continue as going concerns. If a bank tries to collect all its short term-term lending, the borrower is unlikely to remain a going concern and the primary security available to the bank goes for a toss. 

 Succour lies in addressing the broken governance systems. The focus on managing NPAs after the loans have started souring is akin to closing the stable doors after the horse has bolted!

(The author worked with various banks – public, private, and foreign both in India and abroad – for nearly 30 years and is currently on a self-imposed sabbatical to try and understand as to what ails Indian banking and what, if anything, can be done to improve its functioning. Views are personal. The article was first published in Moneylife.)

Tags: bad loansBank reformsEconomy under Modi GovernmentIndian banking industryNPAsRising NPAs IndiaSlider Post

Related Posts

Idea of Republic is Just an Abstract One
Democracy and Rule of Law

Idea of Republic is Just an Abstract One

byMegha Katheria
What the Triple Talaq law means to the lives of Muslim Women
Women's rights

What the Triple Talaq law means to the lives of Muslim Women

byScharada Dubey
Debunking Vaccine Myths—They Don’t Cause Infertility Or Autism
COVID-19

Debunking Vaccine Myths—They Don’t Cause Infertility Or Autism

byDr. Kafeel Khan

Editor's Pick

Can the State Dictate what Religion you will Follow and who you will Marry?

Can the State Dictate what Religion you will Follow and who you will Marry?

byIndira Jaising

India’s Polarised Media Reflects Crisis of Confidence in its Politics

India’s Polarised Media Reflects Crisis of Confidence in its Politics

byRevathi Siva Kumar

Munawar Faruqui:  Real Villain is Divisive Heartland Politics, Not Stand-up Comics

Munawar Faruqui: Real Villain is Divisive Heartland Politics, Not Stand-up Comics

byParsa Venkateshwar Rao Jr

Dilip Chhabria made crores designing cars, then why did he design creative ways to defraud banks?

Dilip Chhabria made crores designing cars, then why did he design creative ways to defraud banks?

byRamesh Menon

Latest by TheLeaflet

Groping ‘Without Skin-To-Skin Contact’ does not amount to sexual assault under POCSO Act: Bombay HC

Groping ‘Without Skin-To-Skin Contact’ does not amount to sexual assault under POCSO Act: Bombay HC

January 24, 2021
Idea of Republic is Just an Abstract One

Idea of Republic is Just an Abstract One

January 24, 2021
What the Triple Talaq law means to the lives of Muslim Women

What the Triple Talaq law means to the lives of Muslim Women

January 24, 2021
Debunking Vaccine Myths—They Don’t Cause Infertility Or Autism

Debunking Vaccine Myths—They Don’t Cause Infertility Or Autism

January 24, 2021

Newsletter

Subscribe to our mailing list to receives daily updates direct to your inbox!

Follow Us

© 2020 TheLeaflet

SUBSCRIBE FOR UPDATES
×

Subscribe to The Leaflet

Enter your email address to subscribe to The Leaflet and receive notifications of new posts by email.

  • Home
  • About Us
    • Why Leaflet
    • Leaflet Team
  • Constitutional Law
  • Human Rights
  • Culture
    • Book Review
    • Movie Review
    • Poetry
  • Humour
  • Issues
    • Analysis
    • Case update
    • Child’s Rights
    • Civil Law
    • Coronavirus and the Law
    • Criminal Justice System
    • Criminal Law
    • Dalit Rights
    • Editor’s Desk
    • Education
    • Environment
    • Fundamental Rights
    • Gender Rights
    • Governance
    • Health Rights
    • History
    • International Law
    • Judiciary
    • Juvenile Justice
    • Know Your Rights
    • Labour Law
    • Law and Technology
    • Litigation
    • Mental Health
    • Policy
    • Politics
    • Right To Informtion
    • Sexual Offences
    • Social Justice
  • Leaflet Specials
    • Independence Day Special
    • Independence of judiciary
    • Right to Privacy
    • Special Issue: Emergency
    • The legacy of Ruth Ginsburg
    • Triple Talaq
    • Two years since Navtej Johar case
  • Videos
  • Historical Series
  • Contact us
    • Write For Us
    • Careers

© 2020 TheLeaflet