It can potentially clean up balance sheets and revive credit demand in the short run but cannot be a solution to the stressed-assets problem
The credit underwriting function in banks needs to urgently bring in new thinking.
By Jagriti Bhattacharyya
In a pandemic-hit economy, India’s banking sector faces a twin-problem—anaemic credit growth and piling bad debt. Although the lacklustre credit demand can be attributed to the economic circumstances prevailing over the last 12-18 months, the banks’ stressed assets crisis has been brewing for several years. RBI’s January FSR projects the GNPAs to increase from 7.5% in September 2020 to 13.5% by September 2021 under the baseline scenario.
Technically, any credit extended for non-consumption purposes should lead to some form of growth. When an enterprise avails credit and puts it to appropriate use, theoretically, there is little reason, without breaking the conditions agreed to during loan sanction, why it cannot be repaid. However, during the last few years, stressed assets have increased manifold, which means that either there has been misappropriation of funds or despite having put the funds to the intended use, it did not result in business growth.
Take the case of large borrowers. The FSR shows that large borrowers account for 73.5% of GNPAs of commercial banks. Despite this, credit managers prefer lending to this segment (accounting for 50.5% of gross advances), thanks to the comfort of collateral, which smaller borrowers cannot afford.
Sans fundamental shifts in lending practices, it is unlikely that any action will ameliorate the soured-debt crisis.
The Budget’s proposal of a bad bank signals the intent to promptly recover amounts from the sale of stressed assets and clear the accumulated NPA rubble, but addressing NPAs for the long term needs tackling of other, deeper issues.
Corporate governance laws need to be strictly implemented and monitored. Banks/FIs should appoint an independent chief compliance/due diligence officer (CCO/DDO), who does not report to the CEO or the promoters, but is answerable only to the central regulator. It is paramount for the CCO/DDO to identify and report instances of related entity lending, camouflaged within the complex maze of corporate structures typical in most large organisations. Associated risks should be carefully evaluated before any sanctioning of loans. These red flags usually become apparent only after an account has gone bad.
Most banks/FIs, to keep operational costs down, tend to prefer large and ostensibly safer borrowers. In doing so, banks not only over-leverage certain customer segments but also create over-reliance on the same collateral, with different banks having varying degrees of ownership claims. RBI’s prudential norms on credit risk management stipulate setting up of internal thresholds to minimise concentration risk pertaining to each sector and industry. In the face of growing bad debts, banks should adopt a pragmatic approach that requires loans above a specified threshold to be approved by a high-level internal committee; credit limits for each borrower monitored at an aggregate level and not just at the individual bank level is also needed.
The credit underwriting function in banks needs to urgently bring in new thinking. Fintech is enabling automation in the entire underwriting process, removing subjectivity by utilising multiple data points to evaluate customers better. Just like the board of directors of well-managed companies endeavour to have individuals from diverse backgrounds, in the same vein, to have a holistic view of the borrower, credit departments should not be composed solely of traditional underwriting specialists. Rather, credit function should be an assimilation of individuals with sectoral, legal, and due-diligence exposure, whose role in the current scheme of things is restricted to obtaining the relevant opinion/clearances.
This will help FIs in segregating the good from the not-so-good borrower and in identifying potential red flags, and deal with such signs promptly.
The so-called proposed bad bank shall lead to transfer/sale of stressed assets to the ARC, which, in turn, will sell them to AIFs and other investors. While this is an attempt to tackle the banking sector’s twin problems with one shot— presumably, clean banks’ books and boost credit growth in the country post the pandemic—it won’t help in separating the wheat from the chaff before loan disbursals are made. Until that happens, irresponsible borrowers having easy access to credit (taxpayers/depositors’ money) will continue to default, leading to piling bad debt, and Indian banks/authorities will perennially be engaged in longdrawn legal battles to recover whatever dues possible. Strong corporate governance coupled with fundamentally sound lending principles that makes credit accessible to all, and not just obtainable by a select few customer segments, are the sine qua non of a robust banking sector. The proposed ARC can potentially clean up balance sheets and revive credit demand in the short run, but cannot be the panacea to India’s stressed-assets problem.
The author is Research scholar, Department of Management Studies, Indian Institute of Science, Bangalore