There might be a delay, some re-scheduling or loan restructuring may be required but eventually the bank will get its money back with interest. There is no need to panic
As we step into the new decade, the woes of the last decade seem to have spilled over into the new one, especially where the beleaguered banking sector is concerned. According to the Reserve Bank of India’s (RBI’s) estimates, the Gross Non-Performing Assets (GNPAs) of banks may increase from 8.5 per cent in March 2020 to 12.5 per cent by March this year. For public sector banks (PSBs), the deterioration is estimated to be more problematic and the GNPAs could be anywhere between 11.3 to 15.2 per cent under the “baseline scenario.” Some Cassandras warn that the situation could be worse. Their relentless scaremongering could potentially hurt economic revival that requires a major increase in bank lending.
In December 2020, scheduled commercial banks had total outstanding deposits of Rs 145,91,773 crore while their outstanding loans and advances added up to only Rs 105,04,536 crore. A bank’s primary function is to lend against deposits and earn enough to make profits after servicing deposits. Data show that banks have enough money to lend more and they must be helped to give more loans. However, a lot of good borrowers are out of the banking net. Banks no doubt face certain risks especially in the prevailing situation due to the pandemic but there is no need to panic. But first, we need to answer the question, what is an NPA? For a bank, an NPA is the amount of loan or an advance for which repayment of any due instalment of principal or due amount of interest is not cleared within 90 days of the “due date.” Interestingly, for agricultural loans it is “within two crop seasons for short duration crops” or within “one crop season for long duration crops.”
If default of payment continues beyond one year of the due date, the NPA is called “Substandard Assets.” If a NPA default continues beyond two years of the due date the NPA is called “Doubtful Assets.” If auditors find that the NPA is due to an incurable default, they classify it as “Loss Assets.” Does anyone expect a business to always make a profit? The answer is an emphatic “no.” Because this is an unrealistic expectation and every business will face a loss or just about break even, many times in its years of existence. This is because how a company makes its money depends a lot on external factors. Likewise, lending is also a business and a bank always runs the risk of a loan or a part of it or the interest not coming in. A bank hoping to lend money only to safe borrowers will not run for long because 100 per cent safe borrowers generally don’t need to take loans or are disinclined to do so.
Past efforts for resolution of Stressed Assets seemed to be showing results because, after reaching a peak of 11.5 per cent at the end of March 2018, the GNPAs of scheduled commercial banks came down to 8.5 per cent by the end of March 2020. So the first thing to note before resorting to scaremongering is that more than 90 per cent of bank loans and advances are being serviced with a delay of 90 days at the most. It does not mean that the remaining bank loans where debt servicing is delayed beyond 90 days are a dead loss for banks because they have enough securities to cover most of these balance loans suffering from problems in debt servicing.
As a pandemic relief measure, all borrowers whose loan accounts were classified as standard as on February 29, 2020, were allowed a moratorium till August 31. This was done to ensure that this period was not counted in the 90 days’ default period and was not classified as an NPA account.
The Supreme Court had in September 2020 directed that no bank account should be declared an NPA until the disposal of pleas seeking an extension of the moratorium period. The final verdict on this is expected soon.
What perhaps escapes attention is that the concerns regarding NPAs or bad loans in popular parlance are exaggerated due to the conservative approach of the RBI. Banks are told to classify loans as performing or non-performing only on the basis of timely repayments of loans and interest, even when there is no erosion in the availability and value of the security or net worth of the borrower/guarantor.
The 90 days’ default rule to tag a loan account as an NPA is a rough and ready, easy to implement, blunt regulatory tool. It indicates an income impairment of the borrower or liquidity risk but certainly not solvency risk. The “income impaired” borrower may or may not be “asset impaired.” Therefore, if we create a new subclass of NPAs based on the 90-day rule, with an assessment of solvency risk, then it should be possible to refine capital adequacy norms and evolve a differential capital adequacy requirement for NPAs where underlying securities are not materially impaired. Betting on the banking sector’s NPA level once the loan moratorium is lifted amounts to betting on the extent of the pandemic’s impact on economic growth and on the incomes of borrowers. Such betting is not economics or mathematics but politics.
If the banks have enough security behind the loan they have given out (house, vehicle, gold, shares, bonds and so on) and the borrowers are not all crooks, the loans will be serviced. There might be some delay, some re-scheduling or loan restructuring required, but eventually the bank will get its money back, with interest. There is no need to press the panic button. Heavens will not fall merely because some loans, interest or equated monthly instalments (EMIs) are not paid within 90 days of the due date.
The Government and the RBI have to take some steps to see that the loans and advances of good borrowers are properly restructured and the debt recovery process becomes efficient in terms of time and value recovered. Banks need to raise additional capital to meet regulatory requirements, depending upon what kind of NPAs emerge. Banks also need liquidity support to service the deposits during the period the borrowers face liquidity problems but have sufficient assets to cover their loan liability.
Every code and every rule book has enabling clauses to deal with exceptional situations. Rules of normal times don’t apply in abnormal times. The pandemic is the time to invoke these exceptional powers to fine-tune the regulatory policy on recognition of a bad loan and the level of additional capital needed by banks to cover definite loss from irrecoverable loans due to the lack and erosion of underlying securities.
The impact of the contagion on the economy is temporary and low inflation has softened what would have otherwise been a harder blow. Assessments and perceptions about population segment-wise distribution of pain may vary according to commentators but it is abundantly clear that at an aggregate level, the nation will recover from the crisis fast enough. A high recovery and low fatality rate, fast resumption of economic activity in several sectors, both formal and informal, as evidenced by several high frequency indicators, are very good signs. Hence, loan servicing will happen albeit with some delay.
By and large, Indian banks are pretty conservative and most of the loans are heavily secured, backed by good valuable securities. The problem comes in enforcing the security because the legal system does not allow it so easily. What we need is a system of vigilance and diligence on the assets mortgaged for the loans and advances. The genuineness and continued existence of assets must be watched and digital tools can be deployed for this.
There is no harm in giving borrowers providing adequate security an extended moratorium. But what we need is a system that will protect the banks’ securities during the moratorium period so that these are not diluted or alienated or encumbered further. We require a robust system of oversight on these securities. This is particularly so for small borrowers below Rs 2 crore who have been helped by the Government based on the Rajiv Mehrishi Committee report.
In India, the credit-to-GDP ratio is just 50 per cent. Many good borrowers like households and businesses depend on informal channels of finance. Indian banks are not lending enough and they are being far too risk-averse. Banks need to use modern digital tools to improve loan surveillance and lend more by using digital technologies to improve credit product design, pre-sanction appraisal and post-sanction oversight on end use. This will help boost the economy of the country in the long run.
(The writer is former Special Secretary, Ministry of Commerce and Industry. The views expressed are personal.)