The Indian banking sector plays a major role as a financial intermediary and is considered to be the main channel of monetary policy transmission, credit delivery, and payment systems. The financial stability of the banking system is a key pre-requisite for overall economic development and financial stability. The Non-Performing Assets (NPA) is an important indicator to analyze the financial health of the banking sector. Besides asset quality, NPAs epitomize credit risk management and efficacy in the allocation of resources. In this article, we will see the causes and effects of NPAs on Banks.
To reflect a bank’s actual financial health in its balance sheet and as per the recommendations made by the Committee on Financial System (Chairman Shri M. Narasimham), the RBI has introduced prudential norms for revenue recognition, asset classification, and provisioning for the advances portfolio of the primary (urban) co-operative banks.
An asset becomes non-performing when it doesn’t generate income for the bank. Earlier an asset was considered as a non-performing asset (NPA) based on the concept of ‘Past Due’.
Causes for the rise in NPAs
- Macroeconomic factors such as lower exports due to the global recession, the downturn in commodity price cycles, etc.
- Most of today’s NPAs are from loans borrowed in the mid-2000s when the economy was booming and business confidence was resilient. But as economic growth became static post the global financial crisis of 2008, the repayment capacity of all the borrowers started diminishing. This lead to what is called India’s Twin Balance Sheet problem, where both the banking sector and the corporates are facing financial stress.
- Political factors like capitalism too have caused high NPAs in India.
- Further, there have also been so many frauds that play an important role in the rising of NPAs. Although the size of frauds as compared to the total volume of NPAs is relatively small, these frauds have been increasing, and there have been no instances of high profile fraudsters such as Vijay Mallya, Nirav Modi, and Mehul Choksey being penalized.
Cases of Effect of Rising in NPAs on Banks:
- The hundred years old Maharashtra based Multi-State Schedule Bank- NKGSB Cooperative Bank has released its 2019-2020 financial reports. During the financial year 2019-20, the bank didn’t perform well due to several reasons including the fallout of the PMC Bank scam. The bank had an increase in NPAs and a reduction in their profits.
Considering the slowdown in the economy from the start of the financial year 2019-20 there was a slight increase in NPA but the bank’s most of the advances were secured by more than 100 % collateral and the bank has started appropriate legal proceedings for recovery of dues.
The PMC Bank fallout had an immense effect on Urban Co-operative Banks. The RBI vide its letter dated April 20, 2020, had asked UCBs having exposure on PMC Bank to provide 20% of their exposure each year over 5 years commencing from the F.Y. 2019-20. This harmed the financials of a large number of UCBs. Due to disclosure with the PMC Bank, they had to provide Rs 15.40 cr. per year starting from F.Y. 2019-20. This disclosure on PMC Bank raised the Gross and Net NPA of the Bank by about 1.5% which was beyond their control. This harmed the Profitability of the Bank. The GNPA stood at Rs. 200.80 Cr last year i.e. 3.82% of Rs. 88.58 Cr advances and NNPA 1.72% of the developments i.e. The F.Y. throughout NPAs have increased significantly in 2019-20. GNPA stood at Rs. 361.07 Cr. i.e. 7.36% at Rs. 243.78 Cr and NNPA 5.09% of the advances, i.e. the company combination stood at Rs. 12,780 Cr as against Rs. 12,852 Cr as of March 31, 2020.
- The revenue of the Kalyan Janata Sahakari bank decreased from Rs 5,175 crore to Rs 5,086 crore as of 31st March 2020 but the total deposit of the bank increased from Rs 3,043 crore to Rs 3,129 crore in the 2019-2020 F.Y.
As per the audited reports, the bank has earned a net profit of Rs 19.07 crore in the 2019-2020 financial year and the net worth stood at Rs 210 crore as of 31st March 2020. The Capital to Risk Assets Ratio (CRAR) is 12.51%.
The NNPA of the bank 2.83 % as of 31st March 2020 and the gross NPA of the bank 5.19% as of 31st March 2020. The bank is trying to bring down not only the existing NPA level but also to minimize slippage of new accounts into the NPA category.
Loans moratorium on banks and NPAs
Banking sector performance had improved in FY20. Various PSU banks that were having high NPAs reported growth in their earnings. Then the Covid-19 crisis emerged and a loan moratorium was announced by RBI.
RBI had announced a loan moratorium on banks to salvage borrowers due to Coronavirus. Loan moratorium means that the borrowers will not be needed to pay interest and principal components of the loan to the bank during the moratorium period.
This is to allow borrowers to improve their investment and companies to thwart low business morale to expand and continue to buoyantly grow their businesses so that economic growth is not compromised.
A stress test conducted by the RBI suggests that the RBI could push Indian banks’ gross bad loans to their highest in nearly two decades. The gross and net non-performing asset (GNPA and NNPA) ratios of all SCBs which had reached 9.3% and 3.7% in September 2019 have declined to 8.5% and 3.0% in March 2020 (Chart a & b). This is evident from the preceding quarterly slippage ratios (calculated as new accretion to NPAs in the quarter as a ratio to the standard advances at the beginning of the quarter) across all bank groups (Chart c). As a result, the provision coverage ratio (PCR) of SCBs improved to 65.4 percent in March 2020 from 61.6 percent in September 2019 (Chart d). NPA provisions have been decelerating for PSBs and FBs since March 2019 (Chart e).
Chart e Growth in SCB’s NPA Provision (y-o-y)
Corporate credit production accounts for 37% of total bank assets and produces 73% of NPAs
In July 2020, credit growth for industry slowed to 0.8 percent, compared to 6.1 percent growth in July 2019.
Sectoral Asset Quality:
Sectors performing well are pharmaceuticals, FMCG, e-commerce, utilities, and IT sectors. Loans to these sectors are not likely to turn bad.
Sectorally, the profitability of service sector bank loans declined in March 2020. The GNPA ratio of the retail loan sector also edged up (Chart a). Among major sub-sectors within the industry, GNPA ratios in respect of construction and gems and jewelry sectors swelled up in March 2020 (Chart b). On the other hand, the infrastructure sector (with a share of 36.2 percent in bank credit to the industrial sector), basic metals (11.3 percent), and electricity (17.5 percent) have shown a perceptible decline in GNPA ratios. This has implications for the aggregate asset quality of the banking sector. Credit growth to food processing, mining, petroleum, coal & nuclear fuels, leather, wood industry, the paper increased in July 2020. Sectors that were hit hard by the pandemic are tourism, aviation, entertainment, hospitality, petroleum, real estate, and food. However, credit growth to chemicals, plastic, infrastructure, gems & jewelry, glass, and beverage & tobacco declined gradually.
So, we see that credit growth would generate high NPAs for sectors affected by the pandemic Retail lending forms 22% of total bank lending and generates 3.7% of NPAs. Car loans, home loans, and personal loans are decent loans and have low delinquencies. Personal loans performed well growing by 11.2% implying NPAs from this segment will be low and banks will enjoy higher margins.
Credit Quality of Large Borrowers:
Large borrowers accounted for 51.3 percent and 78.3 percent of the aggregate loan portfolio and GNPAs, respectively, of SCBs in March 2020 (Chart a). Both these shares have declined since March 2018 implying that, on an incremental basis, credit and NPA accretions are occurring in the small borrower category in the recent period. . The outstanding amount under SMA-0, SMA-1, SMA-2, and restructured standard loan categories and NPAs of large borrowers declined during the quarter ending March 2020 (Chart b). GNPA ratios of large borrowers edged down during the quarter across all banks, except for PVBs (Chart c). SMA-2 ratios of large borrowers plunged across all bank groups, except for foreign banks (Chart d). At the same time, the share of loss assets has been rising within the funded amount for large borrowers (Chart e).
Latest Measures by RBI
The main proposals are:
- Lenders’ Committee with strict timelines for a resolution plan to be established.
- Lenders must be given incentives to agree to collectively and quickly plan
- Improvement in the current restructuring process focuses on viable plans and a fair sharing of losses between promoters and creditors.
- Future borrowing for non-cooperative borrowers with lenders must be made more expensive in resolution.
- Asset sales must be given more liberal regulatory treatment.
- If the loss is fully disclosed, lenders must be allowed to spread their losses on sale for over two years.
- It will not be construed as restructuring if takeout financing is made possible over a longer period.
- If specialized entities are acquiring ‘stressed companies’, leveraged buyouts must be allowed.
- Steps must be taken to facilitate better functioning of Asset Reconstruction Companies.
- Sector-specific Companies/Private equity firms should be helped to play an important role in the distressed assets market.
RBI has significantly reduced the repo rate for some time, but due to financial sustainability, banks have not significantly reduced their lending rates. So, considering the pandemic, the growth of loans in H1 F.Y. 2021 would translate into good earnings for banks. If the moratorium is lifted and repayments begin, it will become lucrative for potential banks. NPAs would rise and in this aspect, RBI has asked banks to do provisioning, buffers, and raise capital and thus be resilient organizations.All banks are facing a lot of problems due to various reasons.PSBs are the lifeline of the Indian economy and the government should nourish them for their sustainability.
Shreya has completed her Graduation in Statistics and currently pursuing her Master’s in Finance from the University of Mumbai. Shreya is a founder of askfinanceguru.com where she posts content related to Finance and management where her motto is to make people financially literate. She has also worked with Finlatics for Financial markets research and Portfolio management live project. She is a learner, She loves to connect with people and seek knowledge from them. She is a hardworking and determined person.