Why don’t we look at lessons from Indian banking history while resolving current NPA crisis..

It was interesting to read RBI DG’s speech on Indian banking NPA crisis. He starts pointing to the scale of the problem and then looks at examples of banking crisis in Japan (1990s)  and Europe (recently).

In the end, he asks several qs in words of William Wordsworth:

So far so good. Oft when on my couch I lie in vacant or in pensive mood, the realization that we have put in place a process that not just addresses the current NPA issues, but is also likely to serve as a blueprint for future resolutions, becomes the bliss of my solitude! A whole ecosystem is evolving around the IBC and the Reserve Bank’s steps have contributed to this structural reform. I smile and rest peacefully at night with this thought… But every few days, I wake up with a sense of restlessness that time is running out; we have created a due process for stressed assets to resolve but there is no concrete plan in place for public sector bank balance-sheets; how will they withstand the losses during resolution and yet have enough capital buffers to intermediate well the huge proportion of economy’s savings that they receive as deposits; can we end the Indian story differently from that of Japan and Europe?

The Government of India has been infusing capital on a regular basis into the public sector banks, to enable them to meet regulatory capital requirements and maintain the government stake in the PSBs at a benchmark level (set at 58 per cent in December 2010, but subsequently lowered to 52 per cent in December 2014). In 2015, the Government announced the “Indradhanush” plan to revamp the public sector banks. As part of that plan, a program of capitalization to ensure the public-sector banks remain BASEL – III compliant was also announced. However, given the correctly recognized scale of NPAs in the books of public sector banks and the lower internal capital augmentation given their tepid, now almost moribund, credit growth, substantial additional capital infusion is almost surely required. This is necessary even after tapping into other avenues, including the sale of non-core assets, raising of public equity, and divestments by the government.

The Cabinet Committee on Economic Affairs has recently authorised an Alternative Mechanism to take decision on the divestment in respect of public sector banks through exchange-traded funds or other methods subject to the government retaining 52% stake. Synergistic mergers may also be part of the broader scheme of things. The Union Cabinet has also authorized an Alternative Mechanism for approving amalgamation of public sector banks. The framework envisages initiation of merger proposal by the Bank Boards based on commercial considerations, which will be considered for in-principle approval by the Alternative Mechanism. This could provide an opportunity to strengthen the balance sheets, management and boards of banks and enable capital raising by the amalgamated entity from the market at better valuations in case synergies eventually materialize.

All of this is good in principle. There are several options on the table and they would have to work together to address various constraints. What worries me however is the glacial pace at which all this is happening.

Having embarked on the NPA resolution process, indeed having catalysed the likely haircuts on banks, can we delay the bank resolution process any further?

Can we articulate a feasible plan to address the massive recapitalization need of banks and publicly announce this plan to provide clarity to investors and restore confidence in the markets about our banking system?

Why aren’t the bank board approvals of public capital raising leading to immediate equity issuances at a time when liquidity chasing stock markets is plentiful? What are the bank chairmen waiting for, the elusive improvement in market-to-book which will happen only with a better capital structure and could get impaired by further growth shocks to the economy in the meantime?

Can the government divest its stakes in public sector banks right away, to 52%? And, for banks whose losses are so large that divestment to 52% won’t suffice, how do we tackle the issue?

Can the valuable and sizable deposit franchises be sold off to private capital providers so that they can operate as healthy entities rather than be in the intensive care unit under the Reserve Bank’s Prompt Corrective Action (PCA)? Can we start with the relatively smaller banks under PCA as test cases for a decisive overhaul?

These questions keep me awake at nights. I fear time is running out. I worry for the small scale industries that Mr Talwar cared the most about, which are reliant on relationship-based bank credit. The Indradhanush was a good plan, but to end the Indian story differently, we need soon a much more powerful plan – “Sudarshan Chakra” – aimed at swiftly, within months if not weeks, for restoring public sector bank health, in current ownership structure or otherwise.

Hmmm…

What was disappointing was that the speech did not mention any lessons from a much bigger NPA crisis in 1990s.  This is not surprising as the speech basically has NPA trends from 2008 onwards.

One came across this speech by G Muniappan of RBI given in 2002 which has some interesting data.

In 1991 when we announced slew of reforms, banking sector was under a really bad shape. In 1993-94, the share of Gross NPA of public sector banks as a % of total advances had peaked to 24.78% and net NPA % was 14.5%.

Year

Gross NPAs

Net NPAs

Amount
(Rs. Crore)

As a percentage to Total Advances

Amount
(Rs. crore)

As a percentage to net advances

(1)

(2)

(3)

(4)

(5)

1992-1993

39253.14

23.18

Not compiled

1993-1994

41041.33

24.78

19690.74

14.46

1994-1995

38385.18

19.45

17566.64

10.67

1995-1996

41660.94

18.01

18297.49

8.90

1996-1997

43577.09

17.84

20284.73

9.18

1997-1998

45652.64

16.02

21232.13

8.15

1998-1999

51710.50

15.89

24211.49

8.13

1999-2000

53294.02

14.02

26187.60

7.42

2000-2001

54773.16

12.40

27968.11

6.74

We get more data in other bankgroups from 1996-97 onwards:

 

 Gross NPA % of total advances All Public Old Private New Private Foreign
1996-97 15.7 17.8 10.7 2.6 4.3
1997-98 14.4 16 10.9 3.5 6.4
1998-99 14.7 15.9 13.1 6.2 7.6
1999-00 12.7 14 10.8 4.1 7
2000-01 11.4 12.4 10.9 5.1 6.8
2001-02 10.4 11.1 11 8.9 5.4
2002-03 8.8 9.4 8.9 7.6 5.3
2003-04 7.2 7.8 7.6 5 4.6
2004-05 5.2 5.5 6 3.6 2.8
2005-06 3.3 3.6 4.4 1.7 1.9
2006-07 2.5 2.7 3.1 1.9 1.8
2007-08 2.3 2.2 2.3 2.5 1.8
2008-09 2.3 2 2.4 3.1 3.8
2009-10 2.4 2.2 2.3 2.9 4.3
2010-11 2.5 2.4 1.9 2.7 2.5
2011-12 3.1 3.3 1.8 2.2 2.8
2012-13 3.2 3.6 1.9 1.8 3.1
2013-14 3.8 4.4 1.8 3.9
2014-15 4.3 5 2.1 3.2
2015-16 7.5 9.3 2.8 4.2
2016-17 9.6 12.1 3.8

It is interesting to note that in early 2000s as PSbs were lowering their NPAs, the NPA was rising in New Private Sector Banks.

Overall we, see that from a high of 15.7% in 1995-96, the share of NPA declined to 2.5% levels in 2006-07. So, it is not as if NPA crisis is really anything new.

What is more interesting is to figure what was done to resolve the crisis?

Rakesh Mohan provided some ideas in his speech (2004):

The reform period also witnessed considerable improvements in the asset quality of banks. Nonperforming loans (NPLs) as ratios of both total advances
and assets declined substantially and consistently since the mid-1990s. Moreover, for the first time since the initiation of reforms, in 2002-03, the absolute amount of NPLs in both gross and net terms witnessed declines (Table 5).

This improved recovery performance raises a few interesting issues. First, from the pattern of NPLs over the years, it can be argued that to a large extent the NPL problems faced by Indian banks are legacy problems emanating from credit decisions taken before the full implementation of the banking sector reforms. Second, there has been a distinct improvement in the credit appraisal process in the Indian banking system under the reform process whereby incremental NPLs have been low despite the fact that Indian industry has gone through a relatively low-growth phase since the mid-1990s. Finally, in recent years, the recovery performance of public sector banks has been better than private sector banks – both old and new – in terms of net NPL (i.e. net of provisioning). Foreign banks, however, exhibited the best recovery performance and lowest NPL levels among theall bank-groups. This raises a question mark on the applicability of the argument that links performance of banks with ownership pattern in the context of Indian banking.

Another interesting point that merits mention is that despite India’s transition to a 90-day NPL recognition norm (from 180-day norm) since 2004, both gross and net NPLs as a percentage of total advances declined between end-March 2003 and end-March 2004. This reflects the success of new initiatives for resolution of NPLs including promulgation of the SARFAESI Act in containing NPLs. Greater provisioning and write-off of NPLs in the face of greater profitability also helped keeping the NPLs low during 2003-04.

Hmm..

Further in an older speech (2002) Dr Bimal Jalan also mentions SARFAESI’s role:

A major drag on financial sector reforms in India is the slow progress in the management of non-performing assets (NPA). Although net NPAs have undergone a steady decline since 1992-93, they are still high by the international standard of about 2 per cent. The cumulative provisions against loan losses at 43 per cent of gross NPAs is also extremely low by international standards. From the regulator’s perspective, NPA management involves four steps i.e., assessment, provisioning, recovery and prevention. A menu approach is adopted in India which involves intensification of recovery with ongoing tightening of norms for assessment and provisioning.

Settlement advisory committees were introduced in 1999 to provide a simplified non-discretionary and non-discriminatory mechanism to deal with the stock or ‘overhang’ of NPAs especially in the small sector. The effectiveness of debt recovery tribunals was enhanced through the amendment of relevant legislation in 2000. In the recent period, there has been a substantial increase in the number of cases disposed of by these tribunals. In 2001, a corporate debt restructuring mechanism as prevalent in the UK and South East Asian countries was finalised for restructuring debts of viable corporate entities. Lok Adalats have proved to be an effective institution for settlement of similar dues. The Union Budget for 2002-03 announced the setting up of a pilot Asset Reconstruction Company with the participation of banks, financial institutions and multilateral agencies. The new Credit Information Bureau will provide an institutional mechanism for sharing of information on borrowers.

A recent landmark development which should have a long term favourable impact in reducing the level of NPAs is the passage of the Securitisation and Reconstruction of Financial Assets and Enforcement of Security Interest Act. It lays out the conditions to be satisfied for the establishment of securitisation or reconstruction companies, the terms for acquisition of financial assets by these companies, enforcement of security interest, dispute settlement procedures, prudential norms, offences and penalties. The Act empowers banks and financial institutions with appropriate legal authority to speed up the recovery of the stock of impaired assets through a one-time cleaning of balance sheets. This is expected to improve their financial health and functioning considerably.

Finally, this speech by Muniappan points to several changes that led to lower NPAs. It is quite an exhaustive list.

I was going through RBI History (1981-97) which also mentions some details. But one has to wait for the history after 1997 to get more complete picture.

So, it is not as if this problem is anything new. The solutions proposed today are most likely old wine in a new bottle with some more additions.

What is surprising is how Indian central bank rarely refers to any history when it looks at any such events. The working papers, speeches etc have no mention of monetary/banking history. Whereas other central banks drive much of their agenda or atleast talk about their decisions largely based on their history.

A clear history and timeline of previous NPA crisis and the measures will be really useful. Then to figure which measure worked and did not work and how these measures are relevant for today will add a lot to our understanding. A lot of questions which Dr Acharya is asking will be automatically answered….

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2 Responses to “Why don’t we look at lessons from Indian banking history while resolving current NPA crisis..”

  1. Anantha Nageswaran Says:

    Frankly, I doubt if Acharya is unaware of history. One, he has participated in at least a few banking sector recapitalisations and NPA resolutions in Scandinavia, etc. Second, the Indian history that you mention offers no new insights that he might be unaware of.

    • Amol Agrawal Says:

      Well if one can pick from Japanese experiences, one can cite Indian experience too. On new insights front, there is nothing new even in Japanese and European ones. My point was not targeting anyone person. It was a general comment. RBI hardly uses any history in any of its own work which is puzzling. US, EU policymakers cite many examples from history which helps in overall understanding. There is no harm in citing examples from India too…

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