Banks' third-quarter results have made it impossible to further ignore a disquieting fact - that banks in India, especially the public sector (PSU) ones that control 70 per cent of the business, have been hiding potential bad loans for far too long. The enormity of it all has now hit, as provisioning by state-run banks for their gross non-performing assets has grown by over Rs 1 lakh crore between September and December, 2015. Compared to the year-ago period, gross non-performing assets (NPAs) of the banking sector as a whole have gone up by almost 50 per cent, from Rs 2.92 lakh crore in December 2014. The massive provisioning followed a directive by the Reserve Bank of India (RBI) that in their December and March quarter results, banks have to fully provide for 150 identified accounts that have been broadly grouped into three categories: borrowers regarded as standard in the books on technical grounds but are actually facing stress; accounts that are in trouble as projects are behind schedule; and accounts where restructuring of loans has failed. More bad assets would be brought on the table in the March quarter and there could also be further slippages, spelling further gloom for PSU banks.
To calm the jittery markets, RBI Governor Raghuram Rajan and Finance Minister Arun Jaitley have played down apprehensions about the health of state-owned banks. But the stark reality is that the current stress felt by India's banks could be just the tip of the iceberg, as the problems run much deeper. That's because the RBI-mandated scrutiny of loans for provisioning purposes is just for 150 accounts. While estimates vary about the percentage of their contribution to the total bad assets problem, one safe assumption is that quite a few accounts besides these could fall in the troubled category soon enough - or perhaps already do - going by the sheer number of indebted business tycoons and a long tail of midsize enterprises. For example, according to Credit Suisse AG, financial stress at the top 10 Indian conglomerates has intensified even as some of them cut back on capital expenditure and attempted to sell assets to pare debt. In its update of an earlier report, Credit Suisse said debt at these groups has risen seven times over the past eight years and their loans add up to 12 per cent of the loans in the banking system in India. It can be argued that this has happened because of a rather long period of regulatory eclipse that allowed banks to remain oblivious to several companies raising their debt to unsustainable levels.
The government has now talked about giving state-run banks "adequate" capital to tide over the problem and has also advised them to raise money from the market while retaining the government's control. Unfortunately, the first option will be regarded as a bailout of powerful business groups who continue to remain unpunished for their failure to honour a financial commitment and behave as if deleveraging and repaying loans are the least of their concerns. What is worse, taxpayer's money is likely to be used to recapitalise banks without any linkage to their performance or past record in preventing accumulation of bad loans. The second option is impractical at a time when many banks now quote at a discount of 75 per cent. After all, which state-owned bank will be valued at close to book by the market? Then there is the problem of banks not having the legal muscle to deal with willful defaulters, with the new bankruptcy Bill still pending in an increasingly fractious Parliament. The only real course of action before the government is to take the P J Nayak Committee report seriously and genuinely reduce the role of government. Only a vigilant board led by a chief executive who comes from outside the "system" can stem the rot. The path leads surely to real disinvestment, and loss of government control. Experience shows that the biggest reforms have happened when there has been an acute crisis. It's time for the "surgery" that Dr Rajan talked about the other day.
