The Cleanup Of Public Sector Banks Is On, But The Basic Problem Remains

What does this mean? As on 31 March 2016, the gross non-performing advances (or bad loans) of banks stood at 7.6 percent of the loans that they have given out. This figure had stood at 5.1 percent as on 30 September 2016. It had stood at 4.6 percent as on 31 March 2015.

This basically means that between March last year and March this year, the bad loans of banks have gone up by 300 basis points. One basis point is one-hundredth of a percentage. Between September 2015 and March 2016, the bad loans of banks have gone up by 250 basis points.

Nevertheless, this is good news. But how can bad loans of banks going up be good news? It is good news because the banks (particularly public sector banks) are finally getting around to recognising bad loans as bad loans. Up until now, they were basically postponing the recognition of bad loans as bad loans by passing them as restructured loans.

As I explained before on Swarajya, a restructured loan essentially implies that the borrower has been given a moratorium during which he does not have to repay the principal amount. In some cases, even the interest need not be paid. In some other cases, the tenure of the loan has been increased.

This is how banks had been helping many borrowers who were no longer in a position to repay the loans they had taken on. In many cases, the restructuring was just an exercise to postpone the recognition of bad loans. Even after the loans were restructured, many borrowers were not in a position to repay their loans.

This has now stopped. The restructured assets of banks as on 31 March 2016 fell to 3.9 percent of loans. In September 2015, it had stood at 6.2 percent of total advances. This basically means that the strategy of banks to postpone recognition of bank loans by passing them off as restructured assets have come to an end. Given this, the overall stressed assets ratio of banks as on 31 March 2016 stood at 11.5 percent, against 11.3 percent as on 30 September 2015.

A stressed asset ratio of 11.5 percent was basically obtained by adding bad loans of 7.6 percent to restructured assets of 3.9 percent. In September 2015, the restructured assets had stood at 6.2 percent, whereas the bad loans had stood at 5.1 percent, leading to a stressed assets ratio of 11.3 percent.

What this tells us is that between September 2015 and March 2016, the stressed assets ratio has gone up by just 20 basis points from 11.3 percent to 11.5 percent. Indeed, this is good news for the simple reason that banks are now being forced to recognise bad loans as bad loans and not pass them off as restructured assets like they were doing earlier.

This is a huge feather in the cap of both the Reserve Bank of India as well as the Narendra Modi government. The basic problem is with public sector banks which gave out loans in the past primarily to many crony capitalists, which these borrowers are now not in a position to repay.

What this means is that public sector banks are cleaning up their act by recognising more and more bad loans. This wasn’t happening in the past. Now it is important that they go after the borrowers (especially the larger ones) and recover as much of the loans as they can. The more the loans they can recover, the lesser will be the capital that the government will have to put into these banks, to get them up and running again.

As the RBI Financial Stability Report points out:

This basically means that RBI was checking for whether banks are recognising bad loans as bad loans.

The Financial Stability Report suggests that:

The point is that the worst is still not over for India’s banks.

Also, this basically means that banks need to be aggressive about recovering their loans. Further, it’s time that the government as the owner of public sector banks, starts forcing the defaulting promoters to give up on their equity.

The Indian public sector banks have ended up in trouble more than a few times before. One of the reasons for this is the politicians forcing these banks to lend to crony capitalists. And as long as these banks continue to remain government-owned, that risk remains, especially given that it is crony capitalists who ultimately finance the electoral ambitions of India’s politicians.

This article was originally published in Vivek Kaul’s Diary – a newsletter that cuts through the noise and presents actionable views on socio-economic developments in India and the world. He is the author of a trilogy on the history of money and the financial crisis. The series is titled Easy Money.