The accompanying chart shows how gross NPAs of banks have grown over the last 10 years or so. There are broadly three phases here. The first is from FY05 to FY08 when NPAs declined and the ratio too came down from a high of 5.2% to 2.3% in FY08. This was also the period when the economy performed very well with growth averaging 8.9% per annum.
The second phase was one of relative stability with the NPA ratio crawling to 2.5% by FY11. In absolute terms, NPAs increased by an average of around R14,000 crore per annum. This was also a period of high economic growth with an annual average rate of 8.1%. Quite clearly, a good economic performance had corporates servicing their debt on time.
The third phase has been quite a disaster as the NPA ratio has started climbing upwards to 3.1% in FY12 and further to 3.4% in FY13, and is expected to go closer to 4.2% by FY14. In fact, the number of R2.43 lakh crore in the chart is for 40 banks as of December 2013, which accounted for around 98% of NPAs in FY13 (R1.80 lakh crore in FY13). Therefore, this number for the entire system will be higher than R2.43 lakh crore in FY14 depending on the accumulation of such assets in Q4FY14. This period has been characterised by one of the lowest growth periods with GDP averaging 5.4% (assuming 4.9% for FY14).
Quite evidently, NPAs have been related with growth conditions. Also, while growth in credit in the last phase was modest, it had been high in the earlier two phases, averaging 27% and 18%, respectively. Loans of long-term nature in the infra space sanctioned in the earlier years when the economy did well would have particularly been affected in the third phase on account of the economic slowdown. While lending judgements have also been on the weaker side, the inaction in the policy area as well as cut-back of spending by the government has had repercussions through backward linkages on companies whose projects have been held up, resulting in debt overhang and low service quality.
Are these numbers ominous The falling quality of assets is a concern across the world and the accompanying table provides information on the NPA ratios for some important countries based on IMF data for Q3 of 2013. Indias NPA profile has to be judged in relative terms with other countries as most nations are going through hard times.
Indias NPA ratio, at above 4% currently, is on the higher side for sure, which has resulted in the Reserve Bank of India (RBI) also do some tough talking with banks. In fact, more than the NPA ratio, the incremental NPA ratio is even scarier (see chart). It had crossed 6% in FY12 and FY13 and looks likely to near 15% this year. The number provided for FY14 in the chart looks at an increase in NPAs for 40 banks of R63,369 crore and juxtaposes the same with the overall growth in credit for the system in these nine months.
The concept of NPAs is actually quite narrow as it covers assets that are declared non-performing. RBI has pointed at the restructured assets in its Financial Stability Report, which are around 6% of total advances. If these are also looked at in incremental terms, the overall banking system would definitely seem more vulnerable.
How do we go about mitigating the creation of these assets Three checks can be thought of here. First, banks have to be more efficient in their evaluation and have to be responsible for the quality of assets. Often, chasing targets of market share make them aggressive in lending, which can have negative consequences when the economy goes downwards. The broader question is how commercial should banks be, given that they are a part of a financial infrastructure that can rock the system. There are no clear answers here because with talks of privatisation and shareholder value, drawing such lines becomes tougher. While pinning responsibility to the management or board looks tempting, it could still be difficult to isolate bank-specific lapses and those caused due to the environment turning adverse.
Second, as a central bank, RBI can link payout of dividend by banks or access to the LAF market with NPAs and put pressure from outside to perform. As banks are custodians of deposit holders funds, the shareholders should logically bear a part of the NPA burden through lower dividends. This can put check on banks to improve their recovery record. Also, the tenets of narrow banking can be reintroduced once certain threshold limits of NPAs are breached.
At the third stage, RBIs announcements on dynamic provisioning, provisions for restructured assets and greater caution on the part of the system would help to cushion the impact on the system.
While the economy will recover and the colour of the clouds will change, one must remember that business cycles are bound to recur, which will make the NPA problem resurface again. Addressing the three steps outlined here would help to buffer the system in the future.
The author is chief economist, CARE Ratings. Views are personal