TRENDS

Bad Loans: How One Government Created a Mess and Another Is Cleaning It Up

Bad Loans

The news that the State Bank of India (SBI) reportedly wrote off bad loans amounting to Rs 20,339 crore in 2016-17, with a collective Public Sector Banks’ (PSBs) write-off of Rs 81,683 crore for the same fiscal, was announced end of last week. A Reserve Bank of India (RBI) audit also reportedly unearthed bad loans higher than what SBI had earlier reported in March 2017.

The above facts have been the subject of news stories such as the PTI report syndicated by various publications, as by The Hindu (“‘SBI wrote off bad loans worth more than ₹20,000 crore last fiscal’”) and The Wire (“SBI Wrote Off Rs 200 Billion Worth of Bad Loans in FY17”). There have been some analytical articles written too on how problematic the situation is with PSBs, bad loans and NPAs, such as a Bloomberg article reprinted by Business Standard (“SBI’s $3.6 bn in hidden bad loans shows how deep India’s banking rot runs”).

FALSE NARRATIVE & MISDIRECTED BLAME

While the above two news reports are mere reporting of facts, the analytical piece is more characterised by the pessimism of negative narratives about bad loans and NPAs. While this last article, too, does not quite lay the blame on the current administration at the Centre, the fact of SBI writing off bad loans upwards of Rs 20,000 crore in 2016-17 and the cumulative increase in the total amount written off – a three-fold jump in five years as reported – is the sort of data that sections of the media and the political opposition wield to criticise the present government. We have, for instance, seen Mr Sitaram Yechury doing so recently, as refuted by The True Picture article “Dear Mr Yechury, Here is the Full Story on Bad Loans and NPAs”. Therefore, the tendency to lay completely misdirected blame at the current government needs to be put in the correct perspective time and again and the facts reiterated.

IDENTIFYING THE PROBLEM

There is no denying the existence of the bad loans and the NPA problem. And no such attempt has been made by the administration in office either. Rather, the government’s action was the exact opposite of denial and circumvention. It went ahead and caught the bull by its horns. It took the bold call to undertake a comprehensive review, uncover the very rot that the Bloomberg/ Business Standard article talks about and weed it out. Understandably, that is not an easy task, nor can it be done overnight. In addition to the above, the government announced the PSB recapitalisation plan last October, which has come into effect last month. Let us look at this issue in some more detail:

  • The first step towards solving a problem is identifying that the problem exists. The RBI audit which has unearthed the bad loans of SBI is in keeping of a process undertaken in 2015, which we will recall later.
  • What is happening now is the uncovering and auditing of bad loans which no longer stay hidden and can, therefore, be clearly accounted for even as the government sets about implementing the PSB recapitalisation process.
  • The SBI and other PSBs are now writing off the bad loans. They are not quite incurring them. That distinction must be kept in mind to understand the difference between what happened under the last administration and what is happening now under the current administration – how bad loans piled up under the watch of one government and how they are being identified, added up and written off under another.
  • Undoubtedly, as the audits are conducted and the bad loans are written off on a yearly basis, the cumulative figures have gone up.
  • It must also be remembered that it is the current government that began the process of unearthing bad loans and NPAs by first conducting the Asset Quality Review (AQR) in 2015 which had first revealed the high incidence of NPAs.
  • Thus, PSBs began the cleaning up process by recognising NPAs and providing for them. Thus, provisioning for expected losses also grew substantially.
  • When we investigate where the bad loans came from, we see that it was between 2008 and 2014 that PSBs had disbursed disproportionate loans to several industries. In fact, the period of 2004-08 was also of a lending boom. When the growth seen in that period declined as global factors and economic mismanagement by the last administration set it, the problem of NPAs began ballooning.
  • Nevertheless, it was between March 2008 and March 2014, that total loans grew from Rs 18.16 lakh crore to Rs 52.15 lakh crore — a threefold increase in 6 years to about Rs 34 lakh crore.
  • Thereafter, total loans rose to only Rs 58.65 lakh crore in the next three years till March 2017, showing the change already visible with the current government in office. All the time, however, stressed assets were growing in volume as a result of the indiscriminate lending in the earlier period.
  • The following figure shows when the bad loans came about and, thus, who was responsible for them:

(Source: Ministry of Finance)

  • Again, when debtors delayed payment for the bad loans given out, no action was taken by the then government between 2008 and May 2014.
  • Moreover, the then government made banks relax the loan classifications and keep these defaulters as non-NPA accountholders.
  • The bad loans were restructured using this mechanism and the losses incurred by the banks in the process were kept under the surface. All the time, the process of granting fresh and additional loans to these defaulters-cum-debtors had continued.
CLEANING UP THE MESS

The genesis of bad loans and consequent NPAs iterated above is the legacy of the last administration that the current one inherited. And, unlike its predecessor, it has tried to neither hide nor ignore it. Its difficulty has been compounded by the fact that, again unlike its predecessor, the current administration did not inherit good global and domestic economic health, nor any tailwind. Under the circumstances, the boldness of its decision to confront the issue of bad loans and NPAs head-on is perhaps even starker.

It is perhaps possible to grow out of bad loans written-off and NPAs when growth is very high, but for various factors such as the global slump as well as long-delayed or previously unthought of structural reforms that the current administration has undertaken, growth had slowed and is now picking up again. But the government still had to solve the NPA crisis and thus it announced the PSB recapitalisation plan in October 2016, perhaps fully aware of the pressure it would be under. But it seems to have had the courage to do what had to be done.

DETAILS OF ACTION TAKEN & VISIBLE RESULTS

Let us, then, look in detail at what action the current government has taken, right down to the Union Budget and the EASE norms:

AQR & NPAs Unearthed

  • As early as 2015, the current government had recognised and classified the problem of NPAs after the Asset Quality Review (AQR).
  • The recognition of the correct amount of NPAs in PSBs had raised the NPA amount from Rs 2.78 lakh crore in March 2015 to Rs 7.33 lakh crore by June 2017. It is this unearthing of what was hidden because of policy and practice under the last government that the amount of NPAs has gone up.
  • Thus, it is precisely because of the correct action taken by the current administration that the correct amount of NPAs was discovered in the first place. So, what the current government did, first of all, was bust the process and system that had nurtured NPAs.
  • What followed the recognition of the correct amount of NPAs was up-front provisioning for losses by the PSBs. Estimating a capital need of about Rs 1.8 lakh crore till fiscal 2018-19, the government provided Rs 70,000 crore up front.

Bankruptcy Code & NCLT

  • The current government also brought in the Insolvency and Bankruptcy Code, which was enacted into law in May 2016. The Code set up the Insolvency and Bankruptcy Board of India (IBBI) as the regulator on October 1, 2017. The National Company Law Tribunal (NCLT) was, of course, already in place.
  • Under the Bankruptcy Code, cases have been instituted in the NCLT for timebound recovery from the 12 largest defaulters in six to nine months, with cases amounting close to Rs 1.75 lakh crore.
  • While timebound recovery was made possible by the bankruptcy law, the Code was also amended to ensure debtors were barred from further involvement in the business of such defaulting companies. No such action had been thought of, let alone taken, by the last government.

RBI Report

  • As per the Financial Stability Report from the RBI, the bankruptcy code has empowered creditors, especially operational creditors who are usually smaller and weaker than financial creditors like banks and include entities like employees, workers, trade suppliers, etc. This is what the RBI report says: “Such creditors were served neither by previous restructuring mechanisms (such as SICA) nor the existing recovery mechanisms (such as SARFAESI)”.
  • Armed with the bankruptcy law, the IBBI and the NCLT, the system saw remarkable progress. Let us see what the RBI has had to say about this:
  • On October 24, 2017, a complete PSB recapitalisation plan of Rs 2.11 lakh crore over the next two years was announced, with recapitalisation bonds as a major component (64%) of the capital infusion plan.
  • The infusion of capital would be via budgetary provisions of Rs 18,139 crore, recapitalisation bonds of Rs 1,35,000 crore, and the balance capital would be raised by banks from the market while diluting government equity (estimated potential of Rs 58,000 crore).
  • On January 24, 2018, the bank recapitalisation process was formally begun, with the announcement of a capital infusion plan of Rs 88,000 crore by a combination of recapitalisation bonds of Rs 80,000 crore and a budgetary support of Rs 8,139 crore. The recapitalisation bonds will have a tenure of 10-15 years and will be issued once the boards of banks commit to the banking reforms.
  • There is also a six-reform agenda, with which the bank recapitalisation process will be carried out. This is the Enhanced Access and Service Excellence (EASE) which puts down 6 parameters for recapped banks to adhere to: Customer Responsiveness; Responsible Banking; MSME-Friendly Banking; Offtake through Technology and Cleanliness; Financial Inclusion and Digitisation; and Better Governance of Banks.
  • A persistent question and allegation when the bank recap plan was announced had been whether the government would be paying from its own coffers. The answer is No. That is why the budgetary provision was made and the rest is to be via recapitalisation bonds. A recapitalisation bond is actually a promissory note from the government to raise funds from the market which the state will pay back in due course. In brief, the recap is not a waiver, unlike what some critics had been alleging.
  • It may be noted here that while these bonds will help top-up bank capital, the interest on these same bonds could become income for lenders too. As growth picks up, these lenders can lend afresh.
  • Furthermore, to ensure that a problem like this does not arise again in the near future, the government is now putting loans above Rs 250 crore under specialised monitoring, as part of ongoing bank reforms.
  • One more reformative provision worked into the recap plan must be mentioned as well: The recap plan is not tailored to only solving the NPA problem. It also aims at making PSBs “Udyami Mitra” to MSMEs, thus simplifying the process by which MSMEs avail loans from banks.
CONCLUSION

In conclusion, it may be said that no matter how the narrative is interpreted or spun by sections of the media and/ or the political opposition, the fact is that PSBs, with SBI being the largest and most important, are now writing off the bad loans which became bad loans because of the indiscriminate and suspect lending under the last government, which appears to have not only made PSBs make these bad loans but also hid the problem which it thus created.

This is the problem that has been systematically unearthed by the actions taken by the present government – and the figures on bad loans that PSBs like SBI have had to write off are part of the same revelations, irrespective of whether the central bank’s audit is matching the banks’ own figures or finding still larger amounts under bad loans. To reiterate, the current government is cleaning up the mess created by its predecessor. It did not create the problem but is solving it – boldly and with sacrifices. The “rot” in India’s banking system may be real – but it would have snowballed into an economic catastrophe and perhaps torpedoed the Indian economy had policy and practice as under the last administration continued. The problem has been identified. Yes, it may look scary. But, at the end of the day, full-fledged corrective action is being taken.