From financing to funding

Ever since RBI relaxed the provisioning norms, banks, especially the public sector ones, have reduced their coverage ratios to bolster their profits, thereby, making the road ahead for themselves even more difficult. Photo: Ramesh Pathania/Mint

Live Mint: Haseeb A. Drabu :Sun, May 26 2013. 08 33 PM IST

The strategy of banks has to be different; they have to move from financing investment to funding structural gaps

The hopes of an early incipient recovery have been considerably dented by the banking sector results that have come in. Both the asset quality as well as the income quality has deteriorated in a manner that is bound to impact the overall economic recovery.

Despite the macroeconomic stress, adverse global situation, and a hostile monetary policy, the banking sector had held up quite well so far; loan growth has been high and interest margins have been maintained. Indeed, the performance of the banking sector in the last few quarters has been such that a disconnect was emerging between the reported earnings and underlying earnings. Not anymore.

The fourth-quarter earnings declared by the bellwether of the Indian banking sector, the State Bank of India (SBI), showed some disturbing trends: almost 8% of its assets are either impaired or infected. The gross non-performing assets (NPAs) and restructured assets stood at 7.73% of the total advances. And given its provisioning policy, what this amounts to is that NPAs, which have not been provided for, account for more than half of the net worth of SBI. Analytically, this is tantamount to writing down the company’s net worth by half.

Going forward, the trend for most of the public sector banks will be a similar story. Indeed, even now, in the case of many public sector banks, NPAs without provision exceed the total net worth of the bank.

Not that the deterioration in asset quality comes as a surprise. Over the last two years, the rate of growth of NPAs has been faster than credit growth. Reserve Bank of India (RBI) data has clearly shown a near 100% growth in NPA, excluding recoveries; and a threefold increase in the growth of gross impaired assets. In its report, the parliamentary standing committee on finance revealed that over $15 billion or more than Rs.83,000 crore worth of corporate loans have turned bad in less than a year-and-a-half. Further, between March 2011 and December 2012, NPAs on corporate advances increased by 190%.

What makes this worse and very different from earlier stressed asset situations is that NPAs are not driven by specific companies but are sector specific. The issue now is that NPAs and restructured assets are not about companies randomly distributed across businesses but are concentrated in three or four sectors.

From a macro perspective, overleveraged sectors rather than overleveraged companies are the problem: 85% of the total stressed assets of the banking sector lie in real estate, power, steel and infrastructure sectors.

This is suggestive that most big ticket NPAs are not caused by poor management nor are these emerging out of a bad business model. Instead, these investments are becoming infructuous because of the regulatory policy framework and the economic environment governing the sector in which the companies operate.

This makes it a chicken-and-egg problem: these NPAs or restructured assets of the banks concentrated in a few sectors will not turn around till the economy turns around. And the economy will not turn around till the banks “fund” the overall recovery at a lower cost.

In operational terms, what this means is that the banks will have to do three things: first, refinance the current debt at lower rates.

Second, increase the maturity profile of the debt in line with the slowdown in growth and project completion. The average project debt profile of Indian corporate sector is less than five years. This puts additional stress on servicing especially during a downturn.

Third, for the next two years, fund the operational expenses. In other words, for the next two years, banks will have to drive economic recovery, not NPA recovery. If the former is done, the latter will automatically get resolved.

Banks are doing restructuring through the CDR (corporate debt restructuring) mechanism. In 2012-13, 129 cases involving debt worth Rs.91,491 crore were referred for debt recast, up from 87 cases with exposure of Rs.67,889 crore.

In addition to this, it is not too well kept a secret that banks are refinancing and restructuring loans. These are currently being done to “evergreen” accounts. As such, much of this is being done in partial or complete violation of the regulatory guidelines. This makes the banking sector very weak and vulnerable. The need is to refinance and restructure in line with the economic cycle and in a constructive manner.

In this context, it might be worthwhile for RBI to relook at some of its more stringent and mechanical prudential norms. And instead of focusing too much on interest rate, focus on relaxing some prudential norms but tighten the provisioning policy. Instead, RBI relaxed the provisioning norms.

Ever since RBI relaxed the provisioning norms, banks, especially the public sector ones, have reduced their coverage ratios to bolster their profits, thereby, making the road ahead for themselves even more difficult.

Haseeb A. Drabu is an economist, and writes on monetary and macroeconomic matters from the perspective of policy and practice.