NPA Crisis: Bank NPAs Crisis in India

Key Word – (Bank NPA)

According to recent figures put out by the RBI, the Gross non-performing assets (NPAs) of the Indian banks had crossed the Rs.8,50,000 crore mark. It would not be inappropriate to say that the NPA problem continues to be the biggest overhang on credit growth and banking sector health in India. Banking NPAs have risen for a variety of reasons. There were bad credit decisions, poor monitoring, laxity in vigilance, connivance of bank employees, poor understanding of project costs as well as routine business downturns. The moral of the story is that most NPAs evolved when the Indian industry went on a borrowing binge in the decade post-2003 and the overhang of those actions is still being felt. But first, how bad is the NPA problem in India?

How Gross NPAs of the banking system have grown…

As the above chart evidences, the public sector banks (PSBs) account for 85 to 90% of the total banking sector NPAs. In fact, if you look at the top 20 banks with the highest level of NPAs, 18 out of them are PSBs. While some private banks like J&K Bank, ICICI Bank and Axis Bank have relatively higher level of NPAs, it is PSBs that are the biggest contributors. In fact, the situation of NPAs in some of the PSBs is almost unsustainable. Consider the chart below…

As can be seen from the above chart, the NPA levels in select PSBs have really touched unsustainable levels and most of these banks have already been referred to prompt corrective action (which we shall see in detail later). But first what caused this mountain of NPAs in the first place?

What caused this mountain of NPAs in the first place?

The former governor of the RBI, Dr. Raghuram Rajan, identified 6 key factors that caused this huge NPA problem for Indian banking industry.

• The overall economic slowdown in India and the demand slowdown in the world was a key reason for the rising NPAs. Most Indian companies had expanded capacities in the first decade of the 21st century and were operating at a sub-optimal 65% capacity utilization.
• Many infrastructure projects got delayed due to delays in statutory approvals, environment clearances, land acquisition delays, infrastructure delays etc. This had created a huge overrun in terms of cost and time in case of many infrastructure projects.
• Indian corporates took on massive leverage both domestic and international and this impaired their financial solvency in the last 5 years. This has been an extremely pronounced trend in sectors like steel, power, textiles, telecom etc.
• Most PSU banks have been hardly recruiting fresh recruits and hence their operations had been under tremendous pressure. They lacked adequate trained and qualified personnel to undertake credit risk appraisal, loan monitoring, follow up with customers etc. This led to NPAs.
• Many large projects in the telecom, power and infrastructure sectors required a very high level of domain knowledge which PSU banking staff did not possess. These allowed promoters to get away with overestimating their project cost and start projects without equity contribution.
• Many borrowers like Vijay Mallya, Nirav Modi, Mehul Choksi, Jatin Mehta etc have become defaulters by choice as they believe that the Indian legal system can do little to recover the money from them. This arrogance has also led to rising NPAs due to wilful defaults.

CDR, SDR, S4A and why they failed to address the NPA issue satisfactorily…

The first attempt by the RBI to address the NPA crisis was in 2001 when the Corporate Debt Restructuring (CDR) scheme was first launched. The CDR enables the banks and lenders to voluntarily agree upon more favourable terms like reduction of interest, extension of loan period, temporary moratorium on payments etc. However, the CDR was not too successful in addressing the NPA problem. Later in 2015, the Strategic Debt Restructuring (SDR) was introduced by the RBI envisaging the transfer of shares of the company by promoters to the lenders to protect the interests of the banks. However, in most cases the market cap of the company itself was a fraction of the total debt and the scheme did not really make sense. In 2016, the RBI launched the Scheme for Sustained Structuring of Stressed Assets (S4A) to address the NPA issue. Under the S4A loans above Rs.500 crores where at least 50% of the debt was sustainable was to be considered. Unlike the SDR, there was no need to oust the existing management as long as it was not a case of wilful default.

More recent steps to curb the NPA menace…

In the last 3 years the government has pressurized banks to make more realistic provisions via its Asset Quarterly Review (AQR) program. In addition, the government has taken 3 important steps to curb the NPA menace in PSBs…

• The Insolvency and Bankruptcy Code (IBC) has been instrumental in pushing a lot of highly stressed companies into forced resolution via sale to willing buyers. Thanks to the IBC, Bhushan Steel has found a buyer in Tata Steel and Amtek Auto may have found a buyer in Liberty Group of London. Of course, there are still major NPA accounts like Videocon and Essar Steel but, at least, the ball has been set rolling. Effective February 2018, the SDR and the S4A have been subsumed into the IBC and they do not exist any longer.
• The Prompt Corrective Action (PCA) has been initiated against banks where the net NPAs cross a threshold. Such banks face stringent restrictions with respect to branch expansion, payment of dividends, senior staff salaries, granular monitoring etc. This is more to put systems in place at the end of the PSB Banks.
• Recently, in the aftermath of the Nirav Modi fiasco the government also passed the Fugitive Economic Offenders Bill, which gives the government sweeping powers to confiscate property belonging to the defaulter even if held in proxy names or in benami names. This could go a long way in curbing cases of wilful default.

What exactly is the Nirav Modi Fiasco?

The NIrav Modi case of cheating PNB will go down as one of the most flagrant instances of wilful default. The Nirav Modi owned Firestar International (a leading global diamond trader) had connived with officials of PNB at the Brady House branch in Mumbai to get fake letters of undertakings (LOUs) issued in their favour. Interestingly, these LOUs were issued without the bank insisting on any margin from the customer, which is unheard of. The officials of PNB had connived with the Nirav Modi group to share the SWIFT password to facilitate transmitting these fake LOUs. SWIFT is the global protocol for transferring money and key documents across banks in different countries.

Based on these LOUs, the international branches of banks like Axis Bank, SBI and Allahabad Bank gave loans to the Nirav Modi Group, which eventually became irrecoverable when Nirav Modi defaulted on these loans. The RBI has already clarified that PNB will have to make the provision of Rs.12,700 crore in this case. But the big question still remains as to how the bank will recover the money from Nirav Modi. More importantly, can India allow such unscrupulous promoters to cock a snoop at the Indian banking system and run away?