Talking Point. Is the NPA crisis set to worsen?

The two questions topmost in people’s minds on the exploding NPA (non-performing assets) crisis are: is the worst over? Are the right steps being taken to contain the problem?

To answer the first, one way could be to go with banks’ proclamations — most have warned that the clean-up exercise (a euphemism for the systematic release of NPAs and increased provisioning) is not complete and could continue till 2017.

This is worrying, not just because of the losses posted, but because of the loss of credibility and trust in the financial sector, since this implies that banks have been masquerading sub-standard assets as standard and recognising income, when they received none.

The extent to which income and profits were overstated in the past would depend on for how long banks had postponed recognising the problem.

GNPAs (gross NPAs) in the system shot up from ₹97,000 crore in 2011 to over ₹3,23,000 crore by 2015, a CAGR of 35 per cent; alongside, restructuring of loans grew more rapidly, by 67 per cent, from around ₹67,000 crore to a whopping ₹5,20,000 crore. It is hard to say whether restructuring was a response to growing NPAs or the NPA growth itself was the outcome of failed re-structuring.

The third dimension is recoveries and write-offs which, on an average, were a third and a quarter, respectively, of beginning NPAs. This meant that new NPAs constituted over 70 per cent of the closing NPAs every year. Clearly, the problem has been allowed to fester for very long, with neither restructuring nor recoveries being effective.

While this problem is largely confined to public sector banks (SBI group and nationalised banks), two aspects of re-structuring are of concern — one, they largely pertain to standard assets (over 80 per cent), which makes us apprehend whether banks have been ‘ever greening’ their portfolio. Two, RBI guidelines apparently permit recognition of income on accrual basis on restructured standard assets and this raises the concern on overstatement of income.

We need to note that recoveries (of interest and principal) constitute about a quarter of a bank’s inflows. The implications of a 14 per cent stressed asset portfolio will become clearer — with deposits declining, this means pressure on borrowings as also capital to make good the cash-flow loss. Therefore, as to whether the worst is over, if data is anything to go by, there appears to be much of the past restructuring that is yet to come home to roost. To be fair, restructuring could turn out to be more beneficial this time or recoveries could get speeded up thanks to the new Insolvency and Bankruptcy Code, but the magnitude of the problem is overwhelming.

To the second question on responses, what we have now is a limited strategy — the RBI is coming down hard on NPAs hidden under restructured loans and is forcing banks to make enhanced provisions and take the losses now rather than later. Consequently, the NPAs of several PSU banks have soared and they have registered massive losses during 2016. While this is undoubtedly needed, this, at best, is an accounting clean-up, but does little to address the real problem of blocked cash flows.

Besides, declining operating profits set limits to the effective provisioning that banks can do. This is clear from the results of two large loss-makers, PNB and BOB, where the loan loss provisions were 147 per cent and 176 per cent respectively, of their operating profits during FY2016. An overt focus on provisioning also raises the worry that recovery efforts could slacken with 100 per cent provisioning, because, as John Kay so well puts it, regulation may end up becoming a substitute for prudential management of risk by banks themselves, with compliance getting reduced to metrics achievement where minima are treated as maxima.

But the new Insolvency and Bankruptcy Code gives us some hope in this matter. In the short term, accounting clean-up and asset sales are helpful, but in the longer term, structural issues responsible for generating NPAs, especially in PSU banks, need to be addressed.

These encompass appraisal standards, credit delivery mechanisms and governance, to name only a few.

The writer is an independent consultant