Indian Banking system is in cross roads- particularly the giant public sector banks. Overburdened with the stressed assets in the form of bad loans or Non-Performing Assets (NPAs) which spiraled out of proportion since FY 2016, it exposed the lacunae of Indian banking system. The issues and problems are manifold and multifaceted as in recent times the problems of banking system was entangled with declined in GDP and manufacturing growth due to demonetization and GST implementation. High levels of NPAs coupled with decline in growth in credit demand and industrial slowdown put further pressure on the Indian Scheduled Commercial Banks (SCBs)- particularly, on the public sector banks (PSBs). What are the degree of these problems and what lies ahead for India’s PSU banks depends on a host of factors and how they are dealt with- which are discussed below.
- Restructuring NPAs
Huge NPA burden has put the Indian PSU banks overburdened, wherein the onus of these bad loans falls swings on their head requiring conversion into effective assets. Gross NPA during 2011-2015 had grown at a high rate of 45.9% for when loan advances by banks had grown at a much lesser 16.2 % growth rate (Livemint.com). Gross NPA of public sector banks stood at a mammoth INR 6,14,872 crore, a jump of 56.4% in the 12-month ending December 2016. And gross NPAs of public and private sector banks taken together had stood at INR 6,97,409 crore by December 2016 as per Care Ratings. (Financial Express, 17 May 2017)
Level of Stressed assets of Scheduled Commercial Banks has seen steady growth throughout the period from March 2015 to June 2017. The RBI’s Annual Monetary Policy Report of April 2017 put the level of stressed assets or the gross NPAs of scheduled commercial banks at 10.3% of total advances. The stressed advances ratio stood at 12.6% as on June 30, 2017. (Figure 1) However, the stressed assets of industry alone had seen sharp rise to about 24% of the gross advances to it as of end June 2017 from more than 17% on end March 2015.
Figure 1: Level of Stressed Assets of SCBs (% of Gross Advances)
RBI restricting guidelines are underway under reforms process started by Raghuram Rajan. The 5:25 and S4A schemes for debt restructuring can create healthy balance sheet for the banks. Banks are allowed to cover more sector now under these schemes and are allowed to convert sustainable part of the debt to standard assets. 5:25 allows a bank to provide 20 or more years’ of loan advance with provision of refinance every 5 years or as feasible. In S4A scheme also burden of refinance provisioning has also been enhanced.
2. Industrial Slowdown to Affect Further Cash Flows of Banks:
High NPA levels of PSU banks have led to slow down of loan advances to the industries amidst uncertainty over loan recovery. This will further hamper on the cash flows, top line operability and productivity of Indian PSU banks. The manufacturing IIP growth during Dec 2016 to May 2017, was sluggish with a monthly average growth of only 2.77% with ultimately contracting in June 2017 by 0.1%. Along with this the manufacturing output contracted by 0.4%. during April-July 2017 period eight core industries’ growth was meager 2.5% vis-a-vis 6% during the same period the previous year.
Moreover, RBI’s Annual Monetary Policy Report maintains that capital constraints, particularly in PSU banks, have obstructed in robust revival of flow of bank credit. (Figure 2) The adverse impact of NPAs and stressed assets in Indian banking system can also be seen in the sectoral flow of credit from the Scheduled Commercial Banks (SCBs) (Figure 3). The largest share of stressed assets or NPAs of the banking system goes to the industrial sector which experiences contraction in flow of credit growth between March 2015 to June 2017.
Figure 2: Bank Group-wise Credit Growth
Figure 3: Sectoral Credit Growth of SCBs
3. Capital Requirement for PSU Banks
Banks are to find ways for sustainable capital infusion. Though government is doing for them. Recently government was thinking to infuse USD 7.7 billion or INR 65,000 crore to infuse liquidity into the industrial sector as part of its fiscal stimulus measure. Out of this government is making a provision of additional INR 25,000 crore liquidity infusion exclusively into the PSU banks. This is in addition to the already budgeted provision of INR 10,000 crore for the PSU banks this fiscal. This is likely to widen the fiscal deficit up to 3.7% of GDP from a targeted level of 3.2% for this fiscal year. However, this timely infusion will give some leg room to the PSU banks to cash flow maneuver. Beyond this, PSU banks have to generate their own resources for their capital requirement- cost cutting and improving productivity of their assets in the short run will give them roadmap for the feasibility of their business operations in the medium to long run.
4. Consolidation of PSU Banks
Consolidation of Indian PSU banks is already going on- for example SBI’s consolidation with its sister banks. Though it is well understood that it’s a pertinent requirement of the time to merge the inefficient smaller off-shoots of the mother banks, the process of consolidation bears its own burden. It carries the inefficiencies and the unfavourable balance sheets into the system and also it’s not easy and immediate to infuse the productive work culture into the existing human resource of these smaller partners- which is where much of the protest these employees were lying. Moreover, it’s likely to further surge the level of NPA of the mother banks as it will inherit their negative balance sheets and the burden of employees’ pension costs. Despite short term difficulties, banking reforms mandate that these smaller inefficient subsidiaries have to be amalgamated to the mainstream banking system.
5. Arresting the Decline in Bottom Line
Public sector banks are facing decline in credit expansion in the past two years due to sluggish growth in credit demand from the industry. In the past two years, non-food credit was growing at only 9 to 11% vis-à-vis 11 to 24% in the prior four year period. This led to decline in the growth of PSU banks’ bottom line. The net interest income (NII) of a group of PSU banks grew at a sluggish rate of 7% in FY 2016 compared to 40% in FY11. Likewise, in FY16, 27 PSU banks posted an accumulated loss of more than INR 17,000 crore. (ET, 26 Dec. 2016) This trend is in fact, worrying. The symptoms of decline in profitability will be visible in the times to come. The banks have to thus focus on the cash flows so as to make it steady such that the decline trend in bottom line can be arrested. This will also need a thorough and prudent cost cutting exercise. Though enhanced technological banking solutions have led to overall cut down on transaction costs, this has not effectively led to overall profitability of the banks. Banks have to resort to other effective measures as well.
6. Prudent Segregation between Merit and Non-merit Assets
The present situation of PSU banks are a result of failure of careful segregation of merit assets from the non-merit ones. This needs the careful merit identification parameters on the advances already made and prioritizing the asset collateral and refinance strategy into an effective process of redesigning or restructuring so that the non-merit assets do not further degrade into NPAs. Early identification helps the banks in designing a overall strategy for all its assets which are likely to face trouble. Here singular approach in dealing with such assets will not work where a comprehensive restructuring policy is required.
7. Adoption of Customized Risk Management Strategy beyond Basel-III
The banks may adopt segment-wise customized risk management strategy also to deal with their non-merit assets once the comprehensive segregation process is done. Because, different assets fall into different categories based on the priority or non-priority areas or different segments, the restructuring some assets may need customized strategy of managing the risks associated with them. Once banks understand the gravity and nature of their risks, it will be easier on their part to design unique customized risk management strategy to deal with specific problems of the specific segments banking business. Here, banks have to focus on and think on new risk management strategies beyond Basel-III norms.