To begin with, let us look at the conventional definition of NPAs. Ever since the economy started slipping, companies have found it difficult to service their loans leading to NPAs' volume increasing from 2.4% in FY11 to 3.0% in FY12 and around 3.6% in FY13. In absolute numbers, they stood at around R1.9 lakh crore in March 2013. The usual reasons are high interest rates and low corporate performance due to pressure on sales and costs resulting in inability to repay loans or service interest payments. One may assume that there is less of mala fide intent and that the wilful defaulters category is not predominant.
The restructuring story is even more interesting. The CDR website shows that the volume of restructured debt has increased continuously, touching R2.72 lakh crore as of September 2013 from R0.9 lakh crore in FY09, and was at R2.29 lakh crore by March 2013. In terms of a ratio as a percentage of total advances, CDR was higher at 4.4%, and even traditionally this ratio has been higher than the declared gross NPA ratio.
The argument given in favour of CDR is that loans have to be restructured when the project cannot take off due to extraneous conditions. We all know that several projects are held up when the governments policy changes or the government does not put in its own share of capital to co-finance a project due to fiscal constraints. When an environment clearance cannot be procured or mining laws create an impasse, then the borrower is disadvantaged. As these are lumpy amounts, the propensity to turn bad is faster and nothing much can be done except restructure the loan as it is beyond the purview of the promoter.
The critics of CDR have two arguments here. The first is that when a loan does not perform, in the absence of malicious intent, which is normally the case, there is always a genuine problem. But when we are talking of channelling deposit money of the public into such projects, there is a certain degree of vulnerability to the financial system, especially if this number is as large as it is today. This also means that the appraisers judgement was not right, which affects the deposit holder. Adding the NPAs to CDRs, the total would stand at 8% for FY13, which is quite scary. The second is that in the absence of any regulatory norms on the classification of such loans, banks may just be incentivised to reconfigure a part of their NPAs as restructured assets, though admittedly there is a rigorous process involved for a CDR case. If this happens, then it would be analogous to ever-greening, which is an issue.
In fact, to get a hang on how banks' income statements are affected, let us look at FY12 which is the latest year for which RBI has provided information on the accounts of our banking system. Total assets of banks were R82,993 billion. Profits were R816.58 billion, yielding a crude return on assets of 0.98%. For the same year, the total provisions made by banks were R915 billion of which 42% were for NPAs, i.e., R381 billion. In FY12, NPAs were 3% of the total advances while the same ratio for restructured assets was 3.2%nearly the same. Suppose all of them were actually treated as NPAs, then the same amount of provisioning would have had to be madewhich in turn would lower net profits to R435 billionwith the return on assets coming down to 0.52%. Now, this is an extreme case and can be debated and debunked. But the point is that restructuring of non-performing loans is a serious issue and given the extent if their prevalence, there is a strong reason to move assets across these categories.
Therefore, RBI is fully justified in warning banks on this issue. Presently, there may be no systemic risk and it is being assumed that banks are trying their best to get the most from these assets and once the economy recovers, the repayments and interest payments will flow through. But we cannot brush aside this problem and do nothing about it. Quite clearly, the appraisal and disbursal processes have to be made more robust.
The problem is even more serious as getting legal redress is not easy and extremely time consuming. While recovery agents can knock on the doors of a retail borrower, the rules are skewed in favour of the large borrower. Therefore, the only way to eschew this problem is not to have it. The onus should be on the banks to control the increase in the number of NPAs to retain the sanctity of the system. This also leads to an interesting issuethat of the grievance of companies, especially in the SME segment, that funds are not easily available. RBI, on its part, must address the broader issue of compelling banks to get into inclusive lending, where such risks may be high and will ultimately impinge on the quality of bank assets. Evidently, at some stage, we must be practical when it comes to lending and let this sense override emotion.
The author is chief economist, CARE Ratings. Views are personal