The Brewing NPAs problem in the Indian Banking Industry

Burning Problem

Indian banking industry is undergoing a big problem of NPA[1] (Non-Performing Asset) crisis in recent years which is eroding the profitability metrics of commercial sector banks, affecting their balance sheets (higher provisions[2]) and in a longer run impacting overall Indian economy as well.

As per recent news, SBI reported a massive 67% fall in consolidated net profit at Rs 1,259.49 crore in the quarter to December 2015, after it classified loans worth Rs 20,692 crore as having turned bad[3]. Other large Public sector banks, to quote a few like Punjab National Bank and Union Bank of India have posted substantial dip in their net profits.

RBI has relaxed the norms as part of proposal on April 6^th 2015, which says banks can take 2 more years for classifying certain asset as NPA. This may help banks on going easy on provisioning against bad loans. But this is going to aggravate the problem further in longer run as it may lead to technical bankruptcy of banking entity wherein they would advance more money than what it has available, as large portion of NPAs may go unreported.

Current Environment and Historical Trends Analysis

Dissecting the problem of NPA in Indian Banking Sector, a thorough analysis is need of the hour to understand the historical and current trends which led the central banking system to later realize the problem and curb it with effective measures.

Data analysis done on banking data released by RBI depicts the problem in efficient manner in explaining how the problem has evolved over years.

It is evident form table 1 that there has been significant improvement in the asset quality of commercial banking sector in India for the period: 1996-97 to 2013-14. From 1996-97 till Mar 2011, there is a steady decrease ( from 15.7% to 2.4%) in Gross NPAs as percentage to Gross advances of all commercial banks; however asset quality is sharply decreasing with increase in Gross NPA of commercial banks since 2011-12 till now ( Please refer Figure 1 ). The sudden increase in NPA could be because of the slowdown in the domestic economy as well as inadequate appraisal and monitoring of credit proposals (RBI, 2012).This might be attributed through decrease in growth rate of advances with increase in growth rate of gross NPA. Performance among the different bank groups with respect to NPA numbers/metrics shows that public sector banks are more vulnerable to the existing problem of NPA crisis, as it is evident in Figure 2 and Figure 3. Figure 4 depicts the share of different bank groups in Total commercial Bank NPA, which further strengthen the notion of greater exposure of public sector banks in ongoing NPA crisis.

[1] NPA: An asset, including a leased asset, becomes non-performing when it ceases to generate income for the bank. As per guidelines issued by the RBI, banks classify an account as NPA only if the interest due and charged on that account during any quarter is not serviced fully within 90 days from the end of the quarter

[2] Provisions: banks are required to keep aside a portion of their operating profit as provisions, higher NPAs will increase the amount of provision thereby impacting the profitability

[3] Citing Sources: [http://www.dnaindia.com/money/report-bad-loans-take-a-toll-on-bottomlines-of-sbi-other-banks-2176743]: para. 2: [Feb 11, 2016]

Table 1 : GNPA in Scheduled Commercial Banks in India

Source – Analysis done on data available at RBI website. For bank Groups please refer Annexure 1.

CAGR – Compound annual growth rate

Notes: 1. Data for 2013-14 are provisional.

2. Data for 2013-14 pertains to all Private Sector Banks

3. Data on Scheduled Commercial Banks & Public Sector Banks for 2004-05 include the impact of conversion of a non-banking entity into a banking entity.

As far as Quarterly performance is concerned, nationalised banks and SBI group posted sharp rise in gross NPA to gross advances ratio. (Please refer Graph 1). Share of All Bank groups in Total Commercial Banks NPA in June 2015 and Gross NPAs to Gross Advances ( in%) June 2015 is depicted below in Graph 2, where it is evident that Nationalised Banks and SBI group banks are having larger pie with respect to other bank groups.

Graph 1 (Source: Data on RBI Website)

Graph 2 (Source: Data on RBI Website)

Root Cause Analysis

Looking at the problem from broader perspective, root causes identified for ongoing NPA problem in Indian Commercial Banking sectors can be summarized as follows:

Fraudulent practices & willful defaults, Diversion of funds to unrelated business, promoters/directors disputes etc.
Inefficient NPA cycle management system with lack of appropriate systems and technology, Lack of robust Internal system for initial borrower due diligence (Pre-sanction), lack of proper credit appraisal system, Lack of proper monitoring and early warning system and inefficient recovery measures by banks
External factors like political/regulatory environment leading to business Loss, changes in economic policies/environment, recessionary trends in economy, power shortage, price escalations, accidents & natural calamity leading to nonpayment of dues
Inadequate legal provisions on foreclosure and bankruptcy
Methodologies used by credit rating agencies and its efficacy in terms of bank loan ratings must be addressed by regulators to create holistic regulatory framework for credit ratings along with umbrella regulator

Corrective Measures for Managing Risk and Internal Inefficiencies

Need of the hour is to understand the different phases of NPA lifecycle of banks with efficient management practices to address issues. As per PWC report, various stages of NPA lifecycle of banks[1] can be summed up as below:

NPA lifecycle

[1] PWC report, May 2014, ‘Growing NPAs in banks: Efficacy of credit rating agencies’ , Page 13

Various stages of NPA lifecycle should be effectively handles through key enablers like regulatory framework, internal policies, Business model, Technology and Internal banking processes.

After understanding the root causes of the NPA problem, a few preventive/curative measures can be suggested to mitigate the credit risk exposure of the Indian Banking Sector:

A) Preventive measures:

It encompasses pre-disbursement policies, risk assessment, risk measurement, and risk-based pricing. These measures are more significant than any curative approach as efficient practice of these will make a greater impact on bank’s profitability and liquidity states.

B) Curative measures:

Following measures should be utilized as a part of reactionary form of risk management.

Installment of Early Warning System as part of post disbursement loan monitoring and better managed credit risk assessment framework
Efficient and well-structured training of bank employees to help them understand and install credit risk framework of the bank with greater understanding on ore credit principles, bank growth objectives, and customers business goals and challenges
Proper alignment of interests between credit and sales staff to avoid mismatch sales volume and respective portfolio quality
Practice of placing a proper techno economic viability study to base future actions in case of adverse business conditions leading to sickness, NPA and default in worst case by borrowers

Conclusion

Recognizing NPA as a key concern for Indian Banking Sector, RBI, Government and other authorities and formulated and initiated various steps in strengthening bank’s profitability and thus overall Indian economy in line with strategic direction envisioned. Reforms in core sectors of infrastructure, power, telecom, metal and mining by Government will lead to reduction in stress in Indian Banking sector. External and regulatory bodies are doing their job in right direction, but need of the hour is internal robust measures, a few of them suggested here, must be encapsulated as bank’s policies and guidelines and implemented at grass root level. This will definitely help banks to reduce future probability of an expanding NPA volume. It is anticipated that recovery here is going to be slow paced but optimistic approach of banks will definitely help them curb the problem in phased manner.

Annexure 1