“The Reserve Bank of India (RBI) has asked banks to step up the lending. Can the banks lend in an economy on the downturn? Is there enough opportunity for borrowing/lending? Is economy really growing?” These questions were asked by N Vaghul, the renowned banker who took the ICICI Bank to great heights.
In a brilliant, comprehensive and lucid address at the Triplicane Cultural Academy on “Crisis in the banking sector: reasons and remedies,” Vaghul referred to the three indicators to know whether an economy is growing or not: is there an increase in power consumption? Is there any growth in revenue bearing traffic? Is there an increase in bank lending?
The renowned banker referred to the public sector banks (PSB) making huge provisions for non-performing assets (NPA) in the third quarter of 2015-16: “the crisis will be further accentuated in the fourth quarter,” said Vaghul and traced genesis of the present crisis.
“So long as a bank lends there will be bad debts. When the economy is in a state of decline there would be an increase in the level of bad debts. Indian economy has been steadily declining since 2011 impacting companies’ profitability. Thus the increase in bad debts shouldn’t be a great surprise,” said Vaghul.
NPAs, restructured and troubled assets...
“Around 2000, RBI came out with a fairly strict norm: if interest is overdue for more than 180 days the account has to be classified as NPA. With most of the bank transactions computerised, the machine took over and automatically disclosed interest overdues and classified them as NPA.
“Anticipating delays and distress, a bank manager could restructure the loan and permit extension up to 7 years to pay interest and principal. Such accounts are categorised as restructured assets and shown separately as such and not as NPA. NPAs and the restructured accounts together would form troubled assets. PSB reckoned such assets in the range of 6 to 10 per cent. However, there were doubts about such reckoning and there were also estimates of such troubled assets at around 26 per cent!
“Reserve Bank Governor Raghuram Rajan sent a team of 300 inspectors who collected information over 3 years on borrower accounts of Rs 5 crore and more. The RBI inspectors found that a large group of accounts treated as good by the banks were in reality troubled assets. Rajan directed that banks should make provision also for restructured assets,” said Vaghul.
Thus suddenly in one blow troubled assets formed a sizeable share of total lending of around 16 per cent. RBI further directed banks that they should make provisions for accounts that are likely to become bad in the future. The result is a dramatic change in which several PSBs reported huge losses in the working of the third quarter due to large provisioning.
Understandably, the capital of many of these banks had been eroded and these are in need of infusion of fresh capital (the budget 2016-17 has proposed a provision of Rs 25,000 crore during 2015-16 but this is considered grossly inadequate).
Five reasons for bad debts...
Vaghul described 5 reasons for bad debts - a corrupt banker who takes money from the borrower for lending, loan given under pressure for meeting targets, political interference or personal influences, genuine error of judgment, changing circumstances and loans given in anticipation of government approvals. Vaghul described the last one as peculiar to India.
Governor Rajan reasoned his strong action stating that with bad debts cleared, banks would become strong, can scale up lending operations and expand credit. Vaghul asked whether banks would become strong just by such cleansing.” PSBs that account for 70 per cent of banking in India can become strong only if the capital is strengthened. But this is not easy and not sustainable without frequent fresh capital induction,” he said.
A remedy suggested by Vaghul is to enact a law that permits bankruptcy or through an asset reconstruction company (the budget proposes both). Vaghul held strongly that bank nationalisation had failed. He pointed to the dramatic changes like the spread of micro finance institutions, payment banks and the advent of digital technologies. These have rendered brick and mortar banks irrelevant.