In an extensive interview with BE’s Kishore Kumar Biswas, Pawan Bajaj, MD & CEO, United Bank of India, touches on some very important issues the banking industry is facing today. Excerpts follow :
Q) How do you see the economic scenario in India?
A. With the advanced and emerging economies poised to chart better growth, the IMF projected the world economic growth accelerating from 3.1% in 2016 to 3.5% in 2017, and 3.6% in 2018 – in which the emerging markets which include India is expected to scale 4.1% in 2016 to 4.5% in 2017 and 4.8% in 2018. India is expected to accelerate from 6.8% to 7.7% during the same period.
I believe that the Indian economy is likely to continue its upsurge in 2017-18 backed by strong domestic demands emanating from public sector investments and housing, 7th Pay Commission and increase in minimum wages. Corporate profitability is like to improve and stock market to remain buoyant. Except sugar, which may be short by up to 19%, all other agricultural products should show healthy growth, pacifying the possibility of food inflation.
IIP after expanding back to back in February and March 2017, shrank by 0.8% in April’17 dragged by a 3.1% decline in manufacturing outputs.
The worrying factor is that the Gross Non-performing assets (NPAs) or bad loans of public sector banks (PSBs) have reached high levels of over ` 6.5 lakh crore, the bulk of which are in sectors such as power, steel, road infrastructure and textiles.
Regulators tried to mop up the excess liquidity from the market by narrowing down the spread between Repo and Reverse Repo. Efforts made by the digitalisation and GST, to be introduced in July,2017, are expected to contribute positively to the government revenue.
Q. UBI has done well in Q4-17 after making loss in Q4-16. Are the performances going to improve in the coming days? What are the major bank-specific challenges at present?
A. It is always satisfying to turnaround immediately after a setback. It helps a lot to rebuild confidence. However, if you further dissect our performance, you will find that after declaring a profit of `256 crore in FY-2015, the Bank has declared profit in seven out of last eight quarters. The only quarter we missed out was Q4FY16, largely due to the after effect of the AQR conducted by the RBI.
We are facing the same challenges as the industry is facing today – asset quality and credit off-take. The NPA in banks has been defining the fate of banking industry for quite some time. It has the combined effect of chocking the income channel, retarding growth of the advance portfolio, depleting the profitability and destabilizing the chain of recycling of fund thereby disrupting the entire economic cycle. In the wake of demonetisation, corporate sector faced major challenges due to inadequate cash flow. Slowdown in demand and stalled projects made it difficult for borrowers to repay debt. Consequently the credit off-take did not improve though huge capacities built up remain unutilised. As a result, NPAs or bad loans of public sector banks (PSBs) reached to unprecedented levels. With subdued credit growth, asset quality issues, increased provisioning requirement due to migration, the profitability of banks including our Bank has been impacted substantially.
We had a session with our field functionaries on the issue, whom we reiterated that we have no other options but to go back to our NPA borrowers. We have taken a challenging target of net reduction of the gross NPA by 10% from its March 2017 level, with at least 10% of it to be recovered from written off accounts.
There has been some softening in credit off-take, which we expect to stabilize over next couple of quarters. We must understand that the currencies which lost their legal tender status comprised 86% of the money in circulation. The combined share of services sector and agriculture in the GDP is close to 65%. Both these segments have cash oriented business models. With the sudden crunch in the money supply in the system, there ought to be an adverse impact on demands.
Of late, things have improved for the better. Albeit liquidity issues in the private sector subsisting, Government has played a stellar role in improving the demand for credit. We have kept an ambitious target of about `5000 crore net increase of gross advances, with concentration in the retail and MSME segments. We are offering some attractive and competitive schemes and have been able to reduce the turnaround time drastically by implementing the hub and spoke model.
I believe home loan is the life blood for the mid-segment real estate to which my bank primarily caters to. I also believe in the medium to longer term the housing sector will outpace the industrial sectors in terms of contribution to the GDP growth. With these beliefs at the back of our minds, we have redesigned our home loan products to make them feature-rich, attractive and competitive. Affordable housing is another extremely potent area having vast scope for financing to which we are concentrating upon.
Q. Schemes like strategic debt restructuring, 5/25, S4A are said to have failed to improve the asset quality and recover NPA. Why? What is your own experience about this and suggest some changes that can be helpful?
A. Originally the RBI came up with Flexible Structuring Scheme, popularly known as 5/25, for new project loans on July 15,2014. In December 2014, the RBI extended the applicability of the Scheme to only those project loans which are classified as Standard and existing prior to July15, 2014, without treating those accounts as restructured, as it would ensure long term viability of existing infrastructure/core industries sector projects, by aligning the debt repayment obligations to the cash flows generated during their economic life. The scheme allowed to extend the repayment, in a structured manner with periodical bullet payment option through refinancing, up to 85% of the economic life of the project.
We must understand that the scheme was brought for improving the viability of Standard long term project loans and not to improve asset quality or recover NPA unlike SDR or S4A. The tag of failure should not be attributed for its inability to improve asset quality or recover NPA,
As flexi-structuring is applicable only to project loans; it can’t prevent slippage of a borrower’s account if delinquencies remain in other non-project facilities of the borrower. Moreover, once the account becomes NPA, the refinancing cycle in-built under flexi structure shall be halted till the NPA tag is removed which reinforces the fact that the Scheme itself is not meant for recovery / upgradation of NPA.
If the regulator considers making the Scheme applicable to all term loans, with certain changes and also to NPA accounts, it may prove to be helpful in upgrading the assets with lesser impact on Bank’s profitability comparable to SDR/S4A. Only under this Scheme the banks will not be exposed to huge haircuts, which the other two schemes envisage.
Strategic Debt Restructuring Scheme (SDR) and thereafter Strategic Structuring of Stressed Assets (S4A) were introduced with the objective of easing NPA pressure. However, both failed to have the expected impact. Till March 2017, we have initiated SDR in 20 cases, conversion into equity could be done only in 8 cases and in not a single case could the change of promoters be effected due to unavailability of suitable investors. The prescribed deadlines are going to approach and the accounts are going to become NPA after that. 5 cases failed summarily and turned into NPA.
S4A has been a non-starter ab-initio. Till now we invoked the scheme in seven cases and implementation could be done only
in two cases.
According to our experience, the following factors have roles to play in the failure of the schemes –
l On implementation of SDR, lenders become the owner of 51% stake, which they have to divest to new capable promoters within 18 months to continue with the performing status of the account. It has not happened in a single case as yet. The deep haircuts being demanded by prospective investors make the Scheme non-productive as it would substantially affect banks’ profitability.
l While borrower’s debt burden is being reduced by conversion of a considerable portion into equity, the bankers are to bear the entire brunt of higher provisioning. For example, if a stressed Company’s shares of Face Value of `10/- are priced at ` 4/- in the market, at the time of conversion of the loan into equity under SDR scheme, the banks have to take the shares @ `10/ creating a provision of ` 6/- ab-initio.
l In current economic scenario the banks are reeling under pressure of huge stressed assets resultant from stalled / delayed projects and projects under implementation, which are kept outside the purview of the S4A Scheme.
l Further, even the operational units across sectors are operating at lower levels, because of economic slowdown. At existing level of operations and the cashflow and with the stock of inputs sufficient to take care of not more than next six months’ operations, it may not be possible to sustain 50% of existing funded debts. In such cases the S4A Scheme cannot be applied.
l Under both the schemes, only the lenders are penalized with higher provisions and deep haircuts, while the defaulting borrowers’ payment obligations get reduced.
RBI’s endeavours to revitalize the stressed assets in the economy through these schemes are no doubt a well intended action, but in the process transferring all the burdens to the banks are telling heavily on the banks. Till now the schemes cannot revitalize any of the stressed accounts but made the banks, already reeling under NPA, poorer with higher provisioning requirements. The schemes need to be relooked and redesigned after taking care of all practical problems they faced during their implementation. The banks must be consulted when the schemes are redesigned. The redesigned scheme should incentivize the banks for implementing the schemes instead of penalizing them.
Q. It is said that the PSBs should look into the improvement of risk and credit assessment ability. Do you think it is really a major problem for PSBs. How can this be improved?
A. It is not that the PSBs don’t have expert risk officers or they don’t practice the modern risk theories and models. In fact they have them as good as anybody else in the market. Accept it or not, today the Indian banking system is run by the officers of PSBs at the senior and top management levels. You must understand and appreciate business matrix of PBSs, the constrains under which they operate, the markets that they cater to, the circumstances under which they have to make loans, the social aspects the PSBs have to take into account while doing their business, the number of stakeholders involved and the humongous stake that is involved. They are vastly different from their private counterparts. By saying this I am not trying to justify our high NPA or low profitability levels, but yes – you cannot compare apples to oranges. Moreover, the mayhem that has been responsible for the blood bath in the industry, have the private banks been able to come unscathed out of it. You check the results of the last six quarters, and you will find that all of them have also reported gross NPA 4-5 times their average.
What I understand is that a strong underwriting system that properly understands and mitigates risk is the first element of credit risk management. It is possible only when risk culture permeates across all levels the bank. We have to strengthen further our sensitivity analysis to evaluate a proposal for how close the projections might be to reality, understanding foreign economies and movements of their currencies, emphasis on avoiding portfolio concentration while sanctioning, and control over the borrower at pre disbursement and post sanction stages. Going by the “three lines of defense model”, the first line of defense is Bank’s internal controls i.e. the credit manager who sanctions the proposal because they know the borrower best. Once they fail, Risk Management and Compliance etc. come as the second line of defense. They have to catch the distress signals in the account. The 3rd line of defense is the internal audit. This model can be used to consolidate risk management, credit approval and appraisal further in banks.
Q. Would merger really be necessary for the prosperity of the PSBs in future? What are the other steps simultaneously needed to address the concerns of the PSBs?
A. Merger and consolidation would be a positive development in the long run and consolidation along with higher capital needs and governance reforms would position the banking system better to support a higher growth and further economic liberalization. The Indian banking industry is highly fragmented with 45 domestic banks while no single bank is capable of participating in a consortium of global magnitude until the process of merger of the remaining associates with SBI is completed.
Consolidation would bring about synergies in business and treasury operations, branch rationalisation, access to cheaper fund, diversification of risks, capacity augmentation and achieving economy of scale leading to optimization of costs.
While advocating for merger, I must also flag-off some of my concerns which are also to be addressed. Firstly the threshold size has to be determined relatively accurately so that we do not create behemoths ‘too big to fail’. Secondly, we should have a vision as to how we want our banking industry to evolve over five to ten years from now and not see consolidation as a short term measure to fix NPA or capital problems. Lastly and most importantly, the issues such as ethnic allegiance, sentiments and morale of employees, HR-level adjustments must be addressed with their due care and compassion to the satisfaction of all stakeholders without which the consolidation would remain a mirage perpetually.
As far as smaller banks are concerned they are likely to be benefitted by more efficient management of capital and some legroom for raising more capital. They will be able to explore new geographies and participate in large credit proposals which they are not able to till now, due to their sizes.
There is a limit up to which the government can continue to infuse capital in banks. In order to make the banks attractive to the global investors, the NPA issue shall have to be resolved with highest priority, the books have to be cleaned to the extent possible and the governance has to be improved drastically to instill confidence among prospective investors.