What’s plaguing Indian Banking Industry?
The banking industry has been dominated over the past couple of years by NPAs, falling stock prices, failing banks and government recapitalization. The fall in specific bank share prices has illustrated both broader economic credit issues and the lack of speed in non-performing asset identification (NPAs). Nevertheless, the problem surrounding PMC bank reminded us that the clean-up in the banking system in India has significant work that needs to be done not only in terms of credit quality but at the same time in terms of systemic corporate governance issues that form the cornerstone of the economic growth.
Four issues that have come to the forefront in the past few years are listed below:
The solution to the first two issues is dependent on lenders ability to evaluate sectoral, corporate and project risk considering the balance sheets while the last two revolve are the level of corporate governance standards.
An alternative way of looking at the above issues is as the building blocks on which every credit system is based. The basic premise of a robust and usable credit system is solutions that answer the fourth point stated. Third point solutions are based on those for the fourth, and so on. Essentially, the approaches to the banking system need to draw on each other. Otherwise, solutions that enable higher capacity for the lending institution based on project assessment will become unless in the absence of basic corporate governance standards.
NPA story of India defined
As of 31 March 2018, the total volume of gross NPAs in the economy stands at 10.35 lakh crores which is interesting as it is around 11% of the entire credit disbursals. 85% of these are a gift from our very own public sector banks. SBI the largest bank of India is sitting on NPAs of Rs 2.23 lakh crore. The ratio of NPA to credit disbursals was a mere 2 odd per cent in 2007-08. The important question to ask is why the tables turned in less than a decade?
One of the reasons is that the nation has experienced an unprecedented credit boom from the period of 2003-04 to 2007-08. Growth of AUM in mutual funds and the rise of NBFC also has played its part in the credit growth. The important point in consideration is that the boom was happening despite the monetary tightening policy. Repo was 9 per cent in 2008 raised from 6 per cent in 2004 and a CRR of 9 per cent from 4.75 per cent. The policy marked a shift with the financial crisis of 2008 and rates were cut to support the economy in distress.
Credit booms are usually followed by banking stress. The expansion of credit was unprecedented, with an average annual growth rate of 18.69%, while nominal GDP growth rates were 12.62. It's rightfully said that every project looks rosy in a period of economic growth. When the tables turned the loans became the NPA’s the bank are not finding difficult to work around with.
PCA framework Explained
Prompt Corrective Action or PCA is a framework under which banks with weak financial metrics are put under watch by the RBI. The Reserve Bank has specified certain regulatory trigger points, as a part of prompt corrective action (PCA) framework, in terms of three parameters, i.e. capital to risk-weighted assets ratio (CRAR), net non-performing assets (NPA) and Return on Assets (RoA), for initiation of certain structured and discretionary actions in respect of banks hitting such trigger points.
Since most bank operations are financed by deposits that need to be repaid, a bank must carry enough capital to continue its operations. PCA aims to help warn both the regulator and investors and depositors when a bank is heading for trouble. The aim is to head off concerns until they hit levels of crisis.
LIC the saving grace for IDBI bank
LIC had to come to the rescue for bailing out IDBI bank picking up 51% cent in the bank and taking it private. The picture looks far from rosy. The massive ₹21,624 crore of capital that LIC infused into the ailing bank last fiscal, has been sucked into the bank’s losses. What’s more, the bank’s bad loan troubles don’t appear to be easing any time soon. Will the so-called synergies for LIC work out is what remains to be seen?
PMC bank fiasco and other banking scams
Co-operative banking institutions account for about 8% of deposits and 9% of advances and loans in India. PMC frequently extended loans to HDIL and not disclosing NPA led to capital erosion for the bank. The bank without adequate capital had to put a stop on withdrawals. PNB Nirav Modi is the most infamous scam that came to limelight. Bank staffers issued fake bank guarantees of worth more than 13k crores over the years. Mehul Chowksi of Geetanjali gems was also named among those in banking fraud. Religare charged Laxmi Vilas bank of misappropriating funds of their fixed deposit.
Recapitalization is the strategy to improve the financial stability of the banks by much-needed capital infusion. Government has continuously made capital infusions to take care of continuous losses of the banks and assist in maintaining capital adequacy ratio. Recapitalization of PSBs in FY20 would support growth by encouraging the flow of credit to the economy, although simultaneously adding to the government’s debt.
It is always possible to be wiser after the event. Nevertheless, we need to research the past to conclude the future. There are lessons to be learned for RBI, Government and the banks. It the regulatory responsibility to track macro indicators such as overall credit growth and decide the monetary policy in accordance. It needs to consider the financial and business cycles. There is no substitute to good governance. The government needs to ensure banks run in the larger national interest but at the same time decision making should be left to the bank board. There is a need to empower the bank boards. Banks need to own the soundness of their credit decisions. The need of the hour is a robust framework for credit decision in the system so that the backbone of the economy keeps flourishing generating prosperity in turn.
Sources: The Hindu, The Hindu Business Line, Economic Times, Business Standard, Forbes India, PRS India, Bank report RBI