Banking sector not yet out of the woods

The Reserve Bank of India’s annual banking report and the latest Financial Stability Report, both of which were released in end-December 2018, suggest that a banking sector recovery is already under way. The reports see “signs of improvement” in credit growth and asset quality in the recent period and assert that the RBI’s revised Prompt Corrective Action (PCA) framework along with the resolution process under the Insolvency and Bankruptcy Code (IBC) are paving the way for “a stronger and more resilient trajectory of balance sheet expansion” for the banks.

So, are Indian banks out of the woods or do these reports paint a rosier-than-reality picture? Data from the Basic Statistical Returns of scheduled commercial banks show a very modest revival of annual credit growth in 2017-18 to around 10 per cent, after declining continuously for six consecutive years, from almost 18 per cent in 2011-12 to 5 per cent only in 2016-17. It is noteworthy that this credit recovery is driven by over 20 per cent credit growth of private sector banks in the last three years in contrast to that of public sector banks at 4 per cent only.

The widely divergent credit growth trajectories reflect more of market share gains by the private sector banks at the cost of PSBs, rather than an across-the-board revival of the banking sector. In terms of the credit-to-GDP ratio, the situation remains grim.

The outstanding credit-GDP ratio has fallen from 53.4 per cent in end-March 2014 to 51.4 per cent by end-March 2018. The incremental credit-GDP ratio (which measures the annual flow of credit) fell from an average 8 per cent of GDP from 2009-2010 to 2013-14, to around 5 per cent of GDP in the four years 2014-15 to 2017-18.

In the first half of 2018-19, the incremental credit-GDP was only 4 per cent. It is clear that the very large lending space being vacated by the PSBs owing to their deteriorating financials, is not being occupied fully by the private sector banks, despite aggressive lending on their part. Given the 63 per cent share of the PSBs in outstanding credit, there cannot be any credit revival in the economy without reviving the PSBs.

It is here that the problems with the banking sector policies under the Modi-Jaitley regime become apparent. NPA recovery through various channels in the last four years increased modestly to ₹4.2 trillion from ₹3.2 trillion in the previous five years, in the backdrop of fresh NPAs rising from ₹5.7 trillion to ₹16.7 trillion.

In contrast, NPA write-offs have increased sharply from ₹550 billion under UPA-II to over ₹4 trillion under the present regime. Out of this, ₹3.2 trillion worth of NPAs were written-off by the PSBs alone (see Table 1). By writing off the bad loans owed to the large corporate groups, those losses were absorbed into the banks’ balance sheets through 100 per cent NPA provisioning.

Frauds on the rise

The other major contributors to the mounting losses of the PSBs are bank frauds, whose instances have significantly increased under the current regime. The fraud committed by Nirav Modi and Mehul Choksey on the Punjab National Bank (PNB) contributed to a jump in the total amount involved in bank frauds from ₹239 billion in 2016-17 to ₹411 billion in 2017-18. Moreover, while this particular fraud was an off-balance-sheet operation, credit-related frauds (or loan frauds) have emerged as the dominant category of bank frauds (Table 2).

Overall, ₹1.33 trillion have been ripped off the banking system by the fraudsters under the NDA rule. There has been a further increase in loan frauds in the first half of 2018-19, with ₹304 billion already lost by the banks in six months. The sharp rise in NPA write-offs combined with increasing instances of bank frauds have led to the declining net profitability of the banks, despite rising operating profits. The 21 PSBs taken together made net losses in the last three financial years (2015-16 to 2017-18) because NPA provisions in each of these years surpassed their operating profits (see Chart).

In 2017-18, despite posting operating profits of ₹1.5 trillion, the PSBs made record aggregate losses of ₹853 billion, on account of NPA provisioning worth ₹2.7 trillion. Moreover, the total net losses made by the PSBs in the last three years amounted to ₹1.14 trillion, which is less than the total amount lost by the PSBs through bank frauds. Even after the massive NPA write-offs in the last four years, the total stock of NPAs stood at ₹10.4 trillion in end-March 2018, of which, the PSBs accounted for around ₹9 trillion. Over 85 per cent of these bad loans are owed to large borrowers, whose credit exposure exceeds ₹5 crore.

Efficacy of IBC, PCA

The latest Financial Stability Report projects the NPA ratio of the PSBs to decline marginally from 14.8 per cent in September 2018 to 14.3 per cent in September 2019. Thus, the PSBs are not being expected to clean up their balance sheets in the foreseeable future.

The efficacy of the Insolvency and Bankruptcy Code (IBC) and the revised Prompt Corrective Action (PCA) framework becomes questionable in this backdrop. Under the IBC, the National Company Law Tribunals have been able to resolve only 50-odd NPA cases till September 2018, involving admitted claims of ₹1.25 trillion. Data provided in the IBBI quarterly newsletter show that seven high-value cases out of the 52 resolved cases till September 2018, involved total claims of over ₹1 trillion. The average realisation by the creditors stood at only around 45 per cent only. Given the current stock of NPAs worth over ₹10 trillion, the present realisation rate under the IBC is likely to inflict another ₹5 trillion loss on the banks over the next few years.

As far as the RBI’s revised PCA framework is concerned, 11 out of the 21 PSBs have been brought under it since April 2017, imposing stringent restrictions on their lending, branch and staff expansion, capital expenditure. By restricting core operations, the PCA framework has been pushing banks further into the red.

Capital infusion into the PSBs by the government was to the tune of ₹900 billion in 2017-18 and over ₹515 billion in 2018-19 (end-December), as reported by the Finance Minister in Parliament. Despite such recapitalisation, the CRAR of the PSBs progressively deteriorated from 12.1 per cent in end-March 2017 to 11.7 per cent in end-March 2018 and further to 11.3 per cent in September 2018. This erosion of PSBs’ capital funds have occurred because of their mounting financial losses on account of NPA provisioning.

Bank recapitalisation in the absence of effective NPA recovery is nothing but a taxpayer-funded bailout. The assertions of a turnaround made in the latest RBI reports are not in keeping with the state of the PSBs.

Bose is an economist and activist. Dasgupta is a research scholar

in JNU.