Given the Rs 1 lakh crore increase in gross NPAs by 42 listed banks, 27 of which are in the public sector – 90% of the increase in NPAs from Rs 3.5 lakh crore in the September 2015 quarter to Rs 4.5 lakh crore in the December quarter came from PSU banks – it is obvious India’s dodgy loans problem is a lot worse than anyone imagined. While gross NPAs rose by Rs 65,000 crore in the March 2014 quarter, Rs 60,000 crore in the June quarter, and Rs 40,000 crore in the September quarter, they jumped by a whopping Rs 99,000 crore in the December quarter. And based on the statements by leading banks, the pain in the March quarter could be similar or worse.
As a result, while RBI Deputy Governor SS Mundra put the dodgy loans (gross NPAs and restructured assets) at 11.3% of advances – 14% for PSU banks – at the end of the September quarter, the number is probably higher now. Based on a sample of 42 banks, gross NPAs for all-banks rose from 5.1% of advances in the September quarter to 6.5% in the December quarter – for PSU banks, they rose from 6.5% to 8.1%.
There is also the issue of whether banks have come out with the real numbers even now. At the level of all banks, based on Mundra’s estimates, culled from the RBI’s Financial Stability Report (FSR) in December, the dodgy loans work out to around Rs 8 lakh crore – that’s 11.3% of total advances of around Rs 70 lakh crore. In October last year, however, Credit Suisse’s (CS) House of Debt series had estimated the debt of the top 10 most-indebted companies at Rs 7.3 lakh crore and it also claimed that most of this debt was still classified as ‘standard’ in the books of banks – of this, CS estimated the stressed loans portfolio of banks would rise another 4.5% of total advances since a large part of the debt of these groups had been downgraded to default and because many of these groups had an interest cover of under 1.
Though RBI has warned about fear-mongering by analysts – that is, it feels the CS and other such estimates vastly overstate the problem – this is probably why it insisted banks start recognizing bad/dodgy loans faster than they would have otherwise. The flipside is that India’s ratings, particularly those of banks, will get affected – that will make raising capital more costly for banks and near impossible for firms whose loans have been declared NPAs; which PSU bank manager will risk the CBI/CAG/CVC wrath and give a loan to these accounts?
But even if you discount the CS numbers, the numbers put out by the RBI FSR are frightening. Based on likelihood of what portion of restructured assets would turn bad and how much money could be recovered by selling them, RBI estimated PSU bank losses could be around 3.8% of advances in September 2015 – see graphic. In a situation of what RBI called ‘unexpected losses’ – presumably this could include situations like the stress on steel loans due to a collapse in international commodity prices – this could rise to over 6% in even the baseline scenario in September 2015; in a medium-stress situation of GDP growth and exports falling and inflation rising, this is expected to rise to 6.8% of advances. Certainly if the sluggish industrial growth seen over the past continues, you can expect NPAs to rise even more.
Since that means the government needs to pump in a lot of capital into PSU banks, it is probably a good idea to seriously consider the idea of a bad bank instead of just throwing good money after bad. A bad bank, needless to say, is not really a bank, it is a process to clean up bad loans, much like the TARP in the US after the financial crisis of 2008. What it involves is the bad bank buying out the loan from, say, a PSU bank and forcing the existing promoters out as well – once the bank has taken a haircut on the loan and the value of equity is reduced to zero, the asset can be sold to another promoter and will be viable since it will cost half or less what it did originally.
The way to fund this is through the government issuing a bond to banks – since the bond will be used to clean up banks, it is to be hoped bond-buyers and credit rating firms will not see this as a breach of the FRBM, but will see this as a positive. Getting dodgy promoters out isn’t going to be easy and requires a big government role. For one, the Chief Justice needs to be co-opted to ensure all bankruptcy/winding-up procedures are put in one court and fast-tracked with daily hearings – strong-arming of the type seen in the Satyam case will also be needed, and only the government can do that. While the RBI is believed to be opposed to a bad bank on grounds banks will no longer be motivated to pursue bad loans, the banks don’t seem to be doing a great job even today since the legal system is being abused by defaulters – making the bond non-transferable or keeping the interest rate on it low could also discourage banks pushing all debt on to bad banks in the future.
Postscript: If the government can get rid of the freeloaders, to use Governor Rajan’s term for defaulting corporates, this will help prime minister Narendra Modi get rid of his suit-boot-ki-sarkaar tag – this will go down as well as Indira Gandhi’s bank nationalization did, except this time it will be for a genuinely good cause.