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Pulled down by a load of bad loans, the performance of the banking sector has remained subdued in the current financial year. The situation is likely to improve with banks following on recoveries and active stressed asset resolution initiated by the Reserve Bank of India (RBI). The Economic Survey for 2017-18, which was tabled in Parliament, said that between March 2017 and September 2017, the Gross Non-Performing Assets (GNPA) ratio of Scheduled Commercial Banks (SCBs) increased from 9.6% to 10.2%.

Overview of the private banking sector in India

Axis Bank, ICICI Bank and Yes Bank have faced a significant rise in Non-Performing Assets (NPAs) according to the ‘Asset Quality Review’ conducted by the RBI in 2015. These banks after adjusting to the RBI’s new stressed asset framework, have witnessed another spike in bad loans in the quarter ended in the March, 2018. Total gross NPAs of the top six private banks reached over Rs. 1 lakh crore as of the end of March. The banks that are included in this comparison are HDFC Bank, ICICI Bank, Axis Bank, Kotak Mahindra Bank, Yes Bank and IndusInd Bank. For the banking system as a whole, the total GNPA stood at Rs. 8.8 lakh crore at the end of the December quarter, 2017.

ICICI Bank and Axis Bank have contributed the most to bad loans. ICICI bank has added just Rs. 7,008 crore in fresh loans in the fiscal year that ended on March 31, 2018. It brought advances of Rs. 5.12 lakh crore. ICICI Bank’s gross NPA ratio has risen from 3.26% in September 2015 to nearly 10% in March 2018. On the other hand, the Yes Bank has seen its loan outlay grow at 27.4% on the Compound Annual Growth Rate (CAGR) basis in 2017-18. Axis Bank’s retail loan book has reached from Rs. 1.1 lakh crore in March 2015 to over Rs. 2 lakh crore in March 2018. This change is more evident for ICICI Bank. It has seen retail advances rise from 42.4% in March 2015 to 56.6% at the end of FY 2017. According to the Axis Bank’s financial results statement for the quarter and year ended on March 31, 2018, “The Bank significantly accelerated NPA recognition in Q4. Slippages for fourth quarter of the FY 2018 stood at Rs. 16,536 crore (Rs. 13,938 crore from corporate lending).”

Siddharth Purohit, Analyst, Angel Broking, said, “The Reserve Bank of India has issued various instructions aimed at resolution of stressed assets, including introduction of certain specific schemes at different points of time. In view of the enactment of the Insolvency and Bankruptcy Code, 2016 (IBC), it has been decided to substitute the existing guidelines with a harmonised and simplified generic framework for resolution of stressed assets.”

Concerns for the private banking sector

Private sector banks have previously stood their ground in India during times of economic downturns. It must also be noted the private sector banks are judged on the basis of their profits. These banks take pride in their low reported NPAs and attribute this to their superior credit skills. Despite the facts that include the deceleration of growth of corporate sales, anemic industrial growth (2.8% for 2014-15) and a constriction on corporate cash flows, the private sector banks with significant exposure to Indian companies appear to be immune to the general economic slowdown.

Private sector banks attribute their performance to better credit appraisal and monitoring along with stringent asset recovery procedures. Private sector banks have done well due to better net interest income margin and fee income and also because of their better credit-deposit and investment-deposit ratio which is higher and is reflected in higher interest income. Their operating efficiency is also higher and they recorded higher Return on Equity (ROE) due to better asset quality.

But lately, NPAs are on a rise in private banking sector as well. In the last five years, private banks have recorded a 450% jump in gross NPAs. According to a report, the gross NPAs of private banks have grown from Rs. 19,800 crore in the FY 2013-2014 to Rs. 109,076 crore in March 2018.

Private banks often manage their bad assets cleverly. As has been reported in the Wire, it is being done by giving fresh loans to an arm of a corporation which is on the verge of turning into a defaulter. This practice of “ever-greening” is rampant in some public sector banks but according to industry insiders, it is more rampant in the private banking sector. At times, they give a loan to an entirely different company with an understanding that the firm will pass on the money to rescue a defaulter.

Another clever way by which private banks manage bad assets is by sanctioning two loans at the same time. While the first loan is disbursed immediately, the second loan is kept on hold and, only if the first loan turns bad in a few years, the second loan gets disbursed to help the borrower service the first loan. Thus, a loan does not become bad for at least three to four years.

Private banks create fee based income for market valuation. Fee based income is considered a riskless steady stream and does not consume capital. By front-loading the fee based income, the bank gets a large sum at one time, which improves its profit. But there is a downside to this as the bank will always be under pressure to maintain the level achieved in the previous year and will therefore have to book more fees every year.

An important aspect of most Indian private banks is the absence of a second line of command. When N. Vaghul was heading ICICI Ltd. (1985-96) and even in the K.V. Kamath regime in ICICI Bank (1996-2009), there was a problem of plenty on the talent front. Now, most of the private banks do not have the strength to recover if the CEO steps down. With the RBI raising the CEO’s retirement age to 70 for private banks, given a choice, probably most chiefs would like to continue till they reach that age and, hence, grooming a successor is not the primary agenda.

Solutions

Though the central finance ministry and the RBI were slow to move towards a solution, they have tackled the NPA problem head on during the last year. The Banking Regulation (Amendment) Act, 2017 is a positive step. The RBI has issued definite directions to banks for time-bound resolution of stressed assets. An impressive 40% of NPAs are now under the IBC process. Other important developments have taken place which is aimed to strengthen the banking system. First, the finance ministry has moved to recapitalise the banks.  This is already yielding results in terms of credit growth. Also through its February 12, 2018 directive, the RBI has fully aligned the stressed asset resolution process to IBC. This is expected to boost the sector. 

Government initiatives towards private banking sectors

Public sector banks are less profitable, more prone to political influence and have higher ratio of non-performing assets (NPAs) than their private counterparts. In 2012, the RBI issued a notification permitting private sector banks to handle central and state government business on complying with certain formalities. This was a step forward in removing the existing discrimination between the private and the public sector banks in India. RBI’s decision to allow the private banks to handle government business not only helped these banks to improve their business but more importantly helped the customers.

Future of these banks

On March 21, 2018, Uday Kotak, Executive Vice-Chairman and Managing Director, Kotak Bank said that private sector banks will account for half of India’s banking industry in the next five years. He stated, “On a delta basis, the entire growth in loans is happening as private sector banks are growing significantly. In the next five years, the 70:30 ratio will move towards 50:50 ratio.”

On February 12, 2018, the RBI said that from March 1, 2018 lenders must implement a resolution plan within 180 days for accounts of at least Rs. 2000 crore. Kotak also said that there is a need to tweak insolvency proceedings after 18-24 months to ensure large assets do not lose value. He said that banks should look at getting 40% of the principal value from such assets undergoing insolvency proceedings.

In an attempt to decode Rs. 82.6 lakh crore banking NPAs, public sector banks accounted for 88.74% of the total gross NPAs in December 2017. The top five among them make 46.76% of the total. In contrary to this, the 21 private sector banks have total gross NPAs of Rs. 93,044 crore which is 11.26% of the total gross NPAs worth of Rs. 8.26 lakh crore. In case of private banks, the scale effect can be seen in case of ICICI Bank and Axis Bank, with gross NPAs of Rs. 33,849 crore and Rs. 19,247 crore each. While ICICI Bank accounts for 4.10% of the total and 36.38% of the private sector banks’ gross NPAs, Axis Bank accounts for 2.33% of the total and 20.69% of private sector banks’ gross NPAs. 19 of the 21 private banks’ share of total gross NPAs is less than 1%, while only two public sector banks, Vijaya Bank and Punjab and Sind Bank, can claim that.