NPAs and stressed assets have developed into a momentous problem which has put the banking sector in a fix.Public Sector Banks (PSBs) are facing difficultyin recuperating from thissituation,with many having entered the prompt corrective action list and others showing quarterly losses in financial reports. The government has also been putting in efforts to help the banks deal with the issue. RBI too has become vigilant to the situation and has been changing regulations accordingly.
It becomes necessary to understand how this crisis came to be to avoid such missteps in future.Accumulation of NPAs in the banking sector was a staggered process and started in 2003. The period between 2003 to 2007 saw policy changes which allowed private sector to participate in infrastructure development. There was a huge credit demand from aviation, telecom and other infrastructure sectors. Infrastructure companies could not expect resources from the shallow bond market so banks became their source of credit. Banks’ lending grew at a rate of 25% during this period. But they didn’t have the skills to gauge the viability of these projects because lending to infrastructure companies was the job of Development Finance Institutions (DFI). This exposed banks to risks they hadn’t dealt with in the past, like the delays in projects due to environmental approvals and policy issues. Lending to infrastructure companies was wrong on another count. Banks generally have access to short term deposits while these projects were of long term maturity. This difference between maturities of assets and liabilities created a mismatch in balance sheets.
The aftermath of the global financial crisis in 2008 saw a counterproductive strategy than what would have been beneficial. In its efforts to support the economy, government encouraged PSU banks to lend more to infrastructure projects. But during 2011-13 the GDP growth rate declined to 6%. Projects started delaying or failing and banks had little help in recovering money from such projects. Banks kept evergreening the loans and the true picture of Indian PSBs wasn’t clear until the Asset Quality Review was initiated in 2015.
The government holds a minimum 51% stake in PSBs. According to World Bank data , GOI had 74% ownership over banks in 2010 while other countries in South Asia like Bangladesh and Sri Lanka the government had a much lower ownership in the banking sector . Such high shares in banking sector by the government puts burden of NPAs directly on public resources. Additionally, the laws governingPSBs are also different. They don’t fall under the Companies Act 1956 but are governed by the Bank Nationalisation Act 1969 whereby in the event of a bank run the government will have to fulfil all the obligations.This difference in regulation makes PSBsless susceptible to scrutiny. This, with the fact that these banks also get swayed under the influence of government makes them much more likely to forward loans to unworthy clients or less profitable sectors of the economy.
The government needs to check if the objectives behind having ownership in the banking sector have been achieved. If not then it must mull over if continuing with the current ownership pattern is beneficial. PSBs without government influence might perform better than they currently do. Further, it reduces the obligation of government to intervene when the bank is weak. New deposit insurance laws with the FRDI bill being passed will help banks become more reliant on insurance money rather than looking to government for support through recapitalisation. There is no point in spending public resources to fund credit forwarded to weak entities. Better accountability of the credit committee too, will help make the banking sector more resilient to bad loans.