Bad loans of Indian banks: Questions galore

Acceleration of the process of classification of bad loans as NPA(Non Performing Asset), by India’s PSU banks has opened the proverbial Pandora’s box as a result of which many convoluted questions are looming large. Unless some consensus is built around a rational road map from here, the solutions to the bad loans issue can be extremely painful for many stakeholders with lasting negative impact on the broader economy.

Below are some of these questions –
•Is recognition of loan as an NPA, tantamount to write-off of the loan?
No. Conversion of a loan into an NPA is just the cognizance, as per set norms, that the loan has ceased to generate interest for the bank and risk of default has risen. However this does not absolve the debtor of her liability to service the debt.
• Do rising NPAs for Indian PSU banks imply a sharp dip in their financial health?
Mounting NPAs are delayed symptoms – at best- of banks’ ailment. Any attempt to establish causality between NPA recognition, and the state of balance sheet would be erroneous. Similarly, seeing NPA recognition even as a symptom of deteriorating balance sheets is incorrect. That PSU banks’ balance sheets have been worsening has been written on the walls for quite a while now. Performance and trends in income statements, balance sheets and cash flows of some large borrowers in critical sectors like power, metals and infrastructure over last 6-8 quarters have been giving clear and loud signals in this regard. Thus it is not the rising NPA recognition that is implying a sharp dip in PSU banks’ health. Instead it is the ebbing prospects of large borrowers of these banks that have been signifying this deterioration – for almost two years.
• What if the banks do not clean up their books quickly?
Firstly, continued defiance of norms to postpone classification of bad loans as NPA does not change the ground realities of weakness in the banks’ loan books. More importantly, faulty classification of loans sustained over a long time can deny banks the much needed support from the government, RBI and shareholders which can aggravate the matters further. Also hidden bad loans in the banking system – if not acted upon expeditiously- can keep on deflating the credit cycle thus hurting the country’s economic progress on the whole.
• How to think of large bad loans to corporates by public sector banks – aren’t they effectively, subsidy provided to the rich by the government? For the sake of fairness shouldn’t the banks be asked to write off loans of rural debtors in acute distress?
Banks have not been instructed by the government to write off loans to the corporate sector as per some policy and so it is not correct to treat any write off as subsidy to the rich. In fact loans had been driven by business considerations – though with the benefit of hindsight at least, it can be said that in many instances due diligence was not up to the mark. Of course instances of wrong doing in loan sanction and disbursal should be identified and punished. Rising quantum of bad debts on the corporate loan books in itself cannot justify large scale write off of rural debts by PSU banks. However on an unrelated note, the government does need to help the revival of rural economy and to ease the anguish due to two failed monsoons on Indians in rural areas. For this it may need to don its welfare state hat and think of ways for direct transfer of subsidy in geographies facing extreme economic duress.

How should the burden arising from bad loans be distributed among various stakeholders? To what extent personal liability of promoters be fixed in case of write off of entire chunks of principal?
Collateral should be used for recovery of debt and for this purpose takeover of assets should be quick and as per set norms. The proposed bankruptcy code can go a long way in achieving this once it is approved by the parliament. In addition debtors should be asked to pay up to the extent of personal guarantees even by liquidating their personal assets. However stretching this beyond a limit – crossing the principles of limited liability- may be counterproductive for the economy over the long term. In addition, it will be important to differentiate between malfeasance, and poor management of business. Similarly, bad credit decisions by bank officials should be treated as incompetence and not as misconduct – unless there is proof to indicate otherwise. Finally, the role of regulatory issues and a slump in commodity prices too needs to be assessed in analyzing the drivers of bad loans, and possible sharing of the concomitant burden. Under-recovery after this exercise will need to be borne by the banks’ shareholders – government, and others.
• How much, and why, should the tax payers share the burden – of dubious credit decisions by the banks, or poor performance of companies that raised loans?
To the extent of its ownership of these banks the government as a shareholder (and thus, the tax payers) will need to bear the impact of under recovery. This development reemphasizes the need for the government to withdraw from the business of running businesses including banks, and to take the direct transfer route for subsidy distribution as per requirement.