Banking sector is the backbone of India’s financial sector—it generates two-thirds of household savings and provides over 90% commercial credit. The success of Make-in-India, Start-up India and Digital India depends on the availability of credit and its expansion, particularly to the SME sector, to bridge the credit gap and finance infrastructure spending requirement. The credit-to-GDP ratio is stagnant for the past decade, at 55%, compared to 120% for countries like China and Korea. Indian economy needs credit expansion, given improved business sentiments, implementation of projects and consumer confidence amidst controlled inflation. The credit gap for employment-intensive MSME sector was 43% in March, with the assumption of minimum 20% and 10% year-on-year credit growth to the sector by commercial banks. The problem in the banking sector is more serious than it looks. The major hurdle is NPAs. The true picture of NPAs came out after asset quality review by RBI, wherein visibly stressed assets have been classified as NPAs. As per the McKinsey report of May, the total value of NPAs and stressed assets is Rs8 lakh crore and Rs9.6 lakh crore, respectively, compared to the total net worth of banking sector estimated at Rs9.24 lakh crore. Gross NPAs of Indian banks increased by 25% from Rs5.7 lakh crore to Rs7.11 lakh crore between FY16 and FY17. Along with the capital requirement of Rs5 lakh crore under Basel III by 2019, this implies a cumulative burden of Rs13-14 lakh crore, almost one-and-a-half times the current net worth of banking sector.
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The gross NPAs to advances increased from 3.4% to 8% between 2013 to 2016, contributed by major increase in NPAs, from 3% to 9.3%, in non-priority sector, and moderate increase of 4.5% to 5.7% in priority sector. The larger chunk of NPAs comes from PSU banks and three-fourths NPAs are in non-priority sector. In 2016, NPAs as percentage of total advances were 11.3% for PSU banks compared to 7% for SBI group and 2.7% for private banks. Though NPA ratio has been lower in private banks, the recent divergence in NPA calculation for Axis Bank and Yes Bank amounting to Rs13,655 crore raises concerns. The operating profits to total assets and return on assets for PSU banks came down to 2% and 0.5%, respectively, in 2016, though foreign and private banks are doing better. Industry-wise distribution of bank credit is skewed—one half of total industrial credit going to infrastructure and basic metal products.
The initiatives to strengthen banking include infusion of capital, provision for primary sector lending, launch of Jan-Dhan Yojana for enhancing deposit base, setting up NIIF, credit guarantee fund scheme to cover for collateral free credit facilities to SMEs up to Rs1 crore. Banking sector is in a bad shape and solutions have been sought in terms of recapitalisation, assets reconstruction, resolution and consolidation. The government has infused Rs82,422 crore between October 2012-November 2016 into PSU banks with a promise of another Rs70,000 crore recapitalisation. However, it is not enough. On resolution front, initiatives to resolve the NPA crisis include implementation of the Insolvency and Bankruptcy Code, 2016, setting up of Asset Reconstruction Company and Banking Regulation Ordinance. Further, RBI is in the process to expand the oversight committee from its current size and extend the scope of scheme for sustainable structuring of stressed assets.
Recently, the government merged five subsidiaries of SBI. Though its success rests on scale economies, there are efforts for mergers of weaker banks with stronger ones. RBI is considering setting up a special cell that will identify cases for revival of weaker banks or takeover by another bank or refer a particular case for insolvency and bankruptcy. RBI revised the framework for prompt corrective action on April 13 to strengthen the capital, asset quality and profitability base of banks through effective monitoring. It suggests preserving profit, injecting capital by promoters/owners and restriction on branch expansion.
Despite these initiatives, rising NPAs have become a big hurdle for credit expansion which could derail India’s growth story. Rising NPAs and slow credit growth will affect returns to assets ratio and sustained income of banks. It’s time to set up special cells having proven capabilities to control the asymmetry of information and moral hazard problems, while selecting viable investment projects before extending loans. This goes well with RBI’s advice to banks to have a system of separation of credit risk management function from the credit sanction process.
Writers: Pravakar Sahoo & Ashwani- Pravakar Sahoo is Professor, Institute of Economic Growth, Delhi; Ashwani is Faculty of Economics, NIT Kurukshetra