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Arguably, the year will be remembered and referenced in days to come for a mixed bag of economic events. If it was for the ushering in the GST regime in the country on the one hand, the unmasking of banking frauds that unfolded the NPA mismanagement story in the Indian banking system, should be the other.

While RBI as the controlling authority of the banking sector of the country had picked up the arduous task of purging the system of bad loans since last three years, the spring cleaning of the long neglected kitchen seemed to be falling flat to a great extent as more rodents continued to scamper around.

A look at the trend of Gross NPAs clocked by the Indian banks showed that compared to March 31, 2010 the NPA level jumped by about four times in five years (end 2015) and eight times by end of 2016. In the same scale, it was 9.75 times in March 2017.

While the Gross NPA to Advance stood at 2.51% on end March 2010, it galloped to rise to 9.32% FY 2017. Data from RBI’s financial stability reports shows that in end September 2017, the figure has already touched 10.2%. Hence, once the NPA arising out of PNB, BoB and other banks are factored in, the final count can be anybody’s guess.

Public Sector Banks ( PSBs) , numbered about 26 ( including SBI and its Associate banks, now merged), stockpiled the lion’s share of the bad loans traditionally and it showed up in the Gross NPA to Advance ratio of 2.03 % in 2010,  soaring up to about 13% at the end of FY 2017. 

India currently ranks fifth globally and on top amongst the BRICS countries on banking NPA count. While the Central Government has been attempting to roll out sort of economic reforms through demonetisation, introduction of Insolvency & Bankrupcy  Code (IBC), GST and other, somehow the case of high NPAs in the banking sector, especially in state-run banks, remains a major concern for the Indian central bank and also, in a way,  for the Narendra Modi government.  It has already turned into a major political issue with the opposition parties accusing the administration for its inability to act early on large corporate loan defaulters such as Kingfisher Airline promoter Vijay Mallya, who left India in March 2016 and diamantaire Nirav Modi and Mehul Choksi who turned fugitive in January 2018 to avoid prosecution after allegedly defrauding banks by diverting part of the funds to the tune of Rs 22000 crores. In both the cases, PSU banks had to bear the brunt.

Then where is the problem in the system? Is it that our banking space, lead by the PSB pack, have not been doing a proper due diligence while assessing the credit worthiness of the borrower? Or is it that too much of political pressure and interference in terms of achieving targets or showing favouritism to a particular industrial group / individual work as a catalyst? Or is it a fall out of a third party nexus wherein the surveyors and valuers purposefully generate flawed reports under the influence of unscrupulous borrowers? Or is it that a part of bank workforce which connives with the borrowers to tweak the system and offer undue benefits like in the case of PNB bank fraud? Or is it much deeper than that, where corporate borrowers, taking refuge of economic slowdown wilfully default or divert the fund.

A survey undertaken by the global consultancy firm Ernst & Young during 2017 titled ‘Unmasking India’s NPA issues – can the banking sector overcome this phase?’ deep dived into the NPA problem of Indian banking space and showed that  87% of the respondents believe that the rise in NPA/stressed asset is due to the diversion of funds to unrelated business or fraud, while 64% opined of lapses in pre sanction due diligence and 54% attributed the inefficiencies in credit monitoring during its life cycle.

A stressed loan on the balance sheet of a bank jeopardises its performance in many ways. As soon as a loan is recognised as NPA based on the impaired repayment of principal and interest beyond 90 days, the statutory provisioning of 15% to 100% of the loan value has to be made as per the RBI guidelines to cover the potential loss. Provisioning kills profit which in turn affects Book Value, EPS and the return on investments.

The other fall out is undoubtedly the risk of erosion of the capital adequacy ratio which is currently pegged at 9% (as per BASEL III norms). Though till date, the banks have not faced such a situation, but a back- of- the-envelope arithmetic shows that if the system GNPA ratio were to spike to an extreme 16.6%, 19 banks would fall short of the 9% mark.

During the boom times of 2003 to 2010, the lending was indiscriminate. Many large borrowers defaulted and subsequently entered into restructuring deals to elongate the repayment timelines, so that they did not toe the NPA mark. RBI prescribed loan restructuring modules like Corporate Debt Restructuring Scheme, Flexible Structuring of Existing Long Term Project Loans, Strategic Debt Restructuring Scheme (SDR) and Scheme for Sustainable Structuring of Stressed Assets (S4A) came to their rescue. In effect, by doing certain “cosmetic surgery”, the banks kept their balance sheets clean. Post 2014, the RBI realised that ‘restructured’ was euphemism for ‘doubtful’.  It took up the issue of stressed loan and fast tracked the remedial measures in order to clean up the dirt which was far exceeding the estimates.

Passing of IBC in 2016 widened the path to a great extent. In June 2017, the RBI took a stern step by releasing the 12 cases involving large non-performing assets or bad loans, identified for resolution under the Code. The pack was led by Bhushan Steel (Rs44,478 crore), Essar Steel (Rs37,284 crore), Bhusan Power and Steel (Rs37,248 crore). According to the RBI, these 12 accounts owe Rs2.5 lakh crore to the system, which constitute around 25% of gross bad loans. National Company Law Tribunal (NCLT) mandates a time frame of 180 days (with a maximum extension of another 90 days) to put the company’s management and assets under an interim insolvency professional who in turn form a creditors committee. The committee will appoint a resolution professional to oversee the process and can change management of the corporate debtor. The committee also has to come up with a resolution plan (approved by 75% majority of the creditors) or decide to liquidate the assets if the resolution plan is not accepted by the NCLT or no plan is formed within the designated time. The IBC route has definitely added speed in the entire process and should progressively bring in transparency.

Another important development, which is expected to complement the cleansing up process, is the discontinuation of all types of debt restructuring schemes allowed by RBI till recently, on February 12, 2018. RBI, through Resolution of Stressed Assets – Revised Framework “decided to substitute the existing guidelines with a harmonised and simplified generic framework for resolution of stressed assets”. 

Mitigation of the NPA malady calls for an all round effort starting with changes in the relevant statutes to give them the legal teeth as required.  For example, the government has already brought in a new piece of legislation, Fugitive Economic Offenders Bill, 2018, to lay down measures to deter economic offenders from evading the process of Indian law by remaining outside the jurisdiction of Indian courts. In the back drop of Mallya-Modi-Mehul episodes, this assumes great significance.

Widening of the scope of “wilful defaulter” supported by Securities and Exchange Board of India (SEBI) will  assist in restricting defaulting borrowers from accessing the equity and debt markets is considered another step in the right direction.

At the operational level, more emphasis is required on the method of due diligence for selecting the borrower and also on proactively managing the account for identifying the early warning signals before it turns bad. This is only possible once banks become more proactive in framing policies or guidelines and implementing it right from the grass-root level, with constant supervision by the top management. Fresh RBI guidelines have laid a firm pathway for improving overall robustness to manage loan frauds and keep off the NPA spectre. Banks need to adopt and implement the measures in true spirit and substance by fixing responsibilities, tweaking changes in its internal process flow, undertaking periodic audit and by putting in place a well synced whistleblowers’ policy.

The road to recovery is long and fraught with challenges that need to be handled cohesively.  The huge amount of public money stuck as bad loans in the hands of few corporations can actually finance a number of socially relevant projects which the country needs on a priority basis. Banks should sustain itself on a healthy balance sheet and not on government doles of recapitalisation.  As Victor Hugo once said “ ...one cannot resist an idea whose time has come..”, we have to wait to see how the Indian banking sector finally emerges out of the NPA conundrum as the “idea” has finally dawned on us. 

The author is the Chief Manager – Risk Management & Legal of Peerless Financial Services Ltd. The opinion expressed in this article is the author’s and not necessarily of his organisation.