P E R S P E C T I V E

banking
Loan flaws breaking banks
The recent arrest of the Syndicate Bank chairman by the CBI exposes how non-performing assets, poor loan recovery and laundering are draining the Indian banking system. Finance Minister Arun Jaitley and the RBI Governor have devised ways to check it, but there is a long  way to go.
By Sanjeev Sharma
Stressed loans in the banking system in India make up for a Rs 5.5 lakh crore gaping hole by some estimates and poses a grave risk to the economy and the financial sector. The alleged corrupt practices in public sector banks and their burgeoning bad loans have come under dubious spotlight in the last few days with the CBI arresting Sudhir Kumar Jain, chairman and managing director of Syndicate Bank, on bribery charges for extending credit to defaulting companies, Bhushan Steel and Prakash Industries.

• FAQs: Banks, loans & NPAs

• How the heist happens

• 8 steps to recover bad loans

banking
Loan flaws breaking banks
The recent arrest of the Syndicate Bank chairman by the CBI exposes how non-performing assets, poor loan recovery and laundering are draining the Indian banking system. Finance Minister Arun Jaitley and the RBI Governor have devised ways to check it, but there is a long way to go.
By Sanjeev Sharma

Stressed loans in the banking system in India make up for a Rs 5.5 lakh crore gaping hole by some estimates and poses a grave risk to the economy and the financial sector. The alleged corrupt practices in public sector banks and their burgeoning bad loans have come under dubious spotlight in the last few days with the CBI arresting Sudhir Kumar Jain, chairman and managing director of Syndicate Bank, on bribery charges for extending credit to defaulting companies, Bhushan Steel and Prakash Industries.

Neeraj Singhal, managing director, Bhushan Steel, has also been arrested by the CBI in what has become a high-profile case involving a major PSU bank and large corporate, bringing into focus the scourge of bad loans or non-performing assets (NPAs) and detection of underhand dealings in allocating loans.

RBI Governor Raghuram Rajan has sounded a note of caution, saying the Syndicate Bank case does not reflect the banking system. “I think the balance has to be maintained, and we have to be careful that while we do a thorough investigation and culprits are brought to book, it doesn't become a witch-hunt which then stalls the entire credit process. We have to be careful,” he said.

The CBI has also begun investigations against IDBI Bank for extending a Rs 950-crore loan to Vijay Mallya’s Kingfisher Airlines, a debt-stricken company, even when the bank’s internal report had warned against it.

There was another major incident in February when Kolkata-based United Bank of India had to suspend lending after reporting a massive loss of Rs 1,200 crore. The RBI conducted a special audit and its chairman and managing director Archana Bhargava stepped down later.

The extent of the NPA problem is massive. A report by Kotak Institutional Equities says the RBI puts the total quantum of impaired assets at 9.8 per cent loans or Rs 5.5 lakh crore at the end of financial year 2014.

In May, the All India Bank Employees Association issued a list of top 406 defaulters against whom banks have initiated legal actions.

The challenges

The NPA problem is more pronounced in public sector banks. Apart from large macro issues like economic slowdown leading to increase in bad loans, PSU banks have intrinsic issues like government ownership, implementation of welfare schemes, management, culture and remuneration.

The issue is staring the government in the face. The government has said NPAs of PSU banks have mounted due to slowdown even as the recovery increased to Rs 33,486 crore in 2014. “NPAs have increased as the economy has slowed down in the last two years,” Finance Minister Arun Jaitley said during Question Hour in the Lok Sabha. The top 30 NPAs of PSBs account for 40.2 per cent of their gross non-performing assets (GNPAs). The top 30 accounts comprising large corporate houses have been identified where banks must place emphasis on recovery and take action.

Delivering a lecture recently at Assocham, RBI deputy governor R Gandhi said the total stressed assets in the banking system (including NPAs and restructured standard assets) as on December 2013 was 10.13 per cent of the gross advances of banks. “A slowing economy is bound to see an increase in NPAs. Notwithstanding economic weakness, the NPAs have registered increases since financial year 2012 which is a cause of concern. The NPA increases have been more pronounced in public sector banks,” he said.

There are various factors affecting the asset quality of scheduled commercial banks (SCBs) adversely, such as slowdown, policy logjams, delayed clearances, aggressive expansion by corporate during the high-growth phase.

However, Gandhi said shortcomings in credit appraisal, disbursal and recovery mechanism, besides the slowdown, were responsible for high NPAs. Lack of robust verification and screening of application, absence of supervision following credit disbursal and shortfalls in recovery have led to the deterioration of asset quality, he added.

Sector push

Some sectors contribute to the bulk of NPAs. Sanjay Doshi, partner, transaction and restructuring, KPMG in India, says sectors like infrastructure, iron and steel and textile industries are the largest contributors to the NPAs. Stalled projects, delayed policy decisions, slowdown, macro factors relating to supply and demand and mismanagement are the reasons for the stress in these sectors.

The GNPAs, with restructured advances, contribute to over 10 per cent of the total advances of the banks, he adds.

The NPAs are measured by the GNPAs to gross advances ratio in percentage terms. Higher the ratio, bigger is the NPA problem. Banks with lower NPAs tend to get higher valuations in the stock market.

While the NPA to gross advances ratio for public sector banks was 3.61 per cent, it was 1.79 per cent for private sector banks. Apart from the economic cycle, there are intrinsic issues with public sector banks that lend to more NPAs. Echoing this, Jaitley said in Parliament that bad loan amounts of PSU banks were much higher than private sector banks and there was no comparison between the two as their functioning was different. He said private banks were circumspect on whom to give a loan while PSU banks have social commitment and cater to a large segment of population, particularly in rural areas.

Finding a way out is going to be more than just balancing the books.

FAQs: Banks, loans & NPAs

What are NPAs

Loans are classified as NPAs when the bank considers that the borrower has not serviced his debt or is unlikely to service his debt as per the terms of the contract. The inability to repay principal or debt for 90 days is an NPA.

What are restructured loans

When companies begin to get stressed on servicing loans, banks restructure loans. This is an earlier stage of an NPA. These loans are where banks give extension on payment, cut interest rates, a time moratorium or a hair cut on exposure. Some companies come out of a restructured package while others become NPAs. These are then sold to asset reconstruction companies.

How it affects a common man

The angst of the common man on NPAs is well founded. While taking a small loan, he is subjected to many checks, including income, solvency, identification, personal guarantees and umpteen reminders on a delayed EMI payment. So, when big companies get away with not repaying thousands of crores in loans, there is heartburn. A company as an entity can go bust but often there are no repercussions for the promoter.

Loan amount matters

If you have a small loan, you are running after the bank but if the loan runs into thousands of crores, the bank is running after you. “The too big to fail” concept is crucial in determining the fault lines of the bank-corporate relationship. In many cases, corporates have so much loan exposure that pulling the plug means endangering the bank’s own balance sheet.

Why PSU banks are more vulnerable

A part of the NPA problem of PSU banks is owing to welfare programmes, agri loans, government schemes, financial outreach for the unbanked and loans to state power boards. A big hit accrues when farm loans are waived. Banks have been protesting the decision of Andhra Pradesh Chief Minister Chandrababu Naidu to waive farm loans.

How the heist happens

Middlemen card: The CBI has arrested 11 persons, some of whom were middlemen between the bank and companies for extending credit facilities. It is alleged that Jain had been negotiating for illegal gratification directly as well as through middlemen for extending favour to companies by granting sanction to financial proposals. These people on behalf of companies and others allegedly enter into criminal conspiracy and obtain gratification meant for the public servant and deliver it to the middlemen on behalf of the public servant, the CBI said.

Direct negotiations: In one case, a public servant was allegedly negotiating with a company for Rs 50 lakh in lieu of credit extension. The officials of the company transferred the money to the middlemen who were also relatives of the public servant. The CBI laid a trap and recovered Rs 50 lakh.

FDs easy target: Officials of Oriental Bank of Commerce and Dena Bank are also suspected of misappropriating funds worth Rs 436 crore from fixed deposit customers. The government has initiated a forensic audit in the alleged scam.

8 steps to recover bad loans

With net non-performing loans (NPLs) and restructured loans comprising 8 per cent of total loans of banks, the banking system faces serious challenges, especially given several banks’ low capital adequacy ratios. Another challenge is that banks need to raise capital of over Rs 2 lakh crore over the next two years to meet capital adequacy norms. However, there are some solutions for fixing the NPA and other issues:

1. Revive economy: Economic recovery can lead to better financial conditions of troubled infrastructure companies. Revival of growth and investment cycle will relieve stress on bank balance sheets. The outlook for NPAs in the coming year is elevated. ICRA estimates as regards asset quality, public sector banks fresh NPA generation rate may remain at elevated levels in the short term. Economic revival will hold the key for reduction in the fresh NPA generation rate. ICRA expects gross NPAs of PSBs to remain at 4.4-4.7 per cent by March 31, 2015, as against 4.4 per cent as on March 2014.

2. Get projects moving: A report by Societe Generale says kick-starting stalled projects will boost the economy and reduce NPAs. Around $134 billion worth of projects are stalled and close to 57 per cent (about $75 billion) is stalled for land acquisition and clearance. The government will be able to revive projects worth $60 billion, or about 45 per cent of stalled projects at various government offices.

3. Strive to recover: The RBI’s enabling framework for addressing the NPL challenges and the government’s weak fiscal solution will help, says a research note by Kotak Institutional Equities. The Finance Minister has said many industries have suffered losses in the last two years leading to their inability to repay loans. The RBI has taken steps to recover bad loans of PSU banks that include creation of the Central Repository of Information on Large Credits to collect, store and disseminate credit data to banks on credit exposures of Rs 5 crore and above, formation of joint lenders' forum, corrective action plan and sale of assets. “The RBI has issued instructions to banks to review slippages in asset classification in the borrowal accounts with outstanding Rs 5 crore and above by the Board of Directors of the bank and review NPA accounts which have registered recoveries of Rs 1 crore and above,” he said.

4. Create bad bank: Establishment of a bad bank and transfer of impaired assets to the bad bank. Asset reconstruction companies can play a similar role in the Indian context.

5. Lower interest rates: These can result in lower interest expenses for borrowers and investment gains for banks that can offset NPLs.

6. Review borrowal accounts: The Management Committee of Board should review top 100 borrowal accounts of below Rs 5 crore in each category of NPA, Jaitley has said. The government has asked banks to be more focused in coordination with other members of consortium, assigning the responsibility at the executive director level, hiring best lawyers and monitoring their performance in defending the bank’s interest in Debt Recovery Tribunals and high courts.

7. Improve performance: Jaitley has said they have taken some decisions to professionalise the management of banks and expect banks to have better risk management. RBI Governor Raghuram Rajan has said the RBI and government are working on solutions to improve performance of public sector banks, including improving boards, separation of CEO and chairman role and reducing the government stake to improve bank governance. About 70 per cent assets are handled by PSU banks. Banks have been asked to share information about lenders, cooperate in recovery, and form the Joint Lenders Forum.

8. Fortify legal framework: In a report, Crisil has called for policy makers to strengthen legal and recovery frameworks, and work towards a stronger bankruptcy code to ensure that recoveries become structurally faster.