Govt banks have 90% of NPAs

But the RBI doesn't have the leverage to meaningfully change the way in which public sector banks operate

The Reserve Bank of India’s (RBI’s) actions in punishing Axis Bank and Yes Bank, for under-reporting non-performing assets (NPAs), signals that it wants to get tough. Unfortunately, it is not in a position to do this in the same way with public sector banks where the rot in terms of under-reported NPAs is probably a lot worse. 

The market response to the news was also interesting and perhaps, a little puzzling. In both cases, the central bank curtailed the tenure of the respective CEOs. That led to a massive fall in share prices. Was that a rational market response? Arguably, if the CEO is responsible for having racked up massive NPAs and then under-reported those, surely shareholders should be happy to see him, or her, leave? 

These two actions do set a precedent: If there's under-reporting of NPAs in a private bank, the RBI can be expected to come down hard on the management and that should, over time, lead to better internal auditing standards. However, the RBI lacks the leverage to do this in public sector banks and that's where roughly 90 per cent of NPAs lie. 

The bulk of those bad loans are either directly in the infrastructure sectors such as power, roads and telecom, or in connected areas such as the steel industry. RBI data shows that bank credit to infrastructure peaked in 2015-16 at about Rs 9.7 trillion and has since eased down to just below Rs 9 trillion.  While exposures in power, telecom and other areas have remained almost static in the last three fiscals (2015-16 to 2017-18), exposures to the road sector have come down sharply.  

Bankrupt road projects have seen takers, albeit at steep discounts. That's because many of these road projects that went sour, ran into trouble due to over-optimistic bidding rather than lack of absolute viability. The roads will get built and used (or have already been built) in most cases. The power sector NPAs are much worse in real economic terms. Many of those are in incomplete, unviable projects. There's little to recover and no takers. 

There's another worrying signal where infrastructure investments are concerned - investments have fallen well below projections in the last five years. Between 2002-07, in the Xth Five Year Plan, infrastructure investment was envisaged to hit Rs 8.7 trillion and actually crossed Rs 9 trillion. In the XI-th Five Year Plan (2007-2012) investments were projected at Rs 20.5 trillion and actually reached Rs 23.8 trillion, according to NITI. But in 2012-17, during the XII Five year Plan, investments were projected to reach Rs 55.75 trillion but only reached Rs 37.24 trillion. 

That slowdown is no surprise given that NPAs started mounting and banks hit sector-exposure limits. But it also means that infrastructure capacity creation is stalling and that's going to be a roadblock when it comes to future GDP growth. 

According to the RBI and the International Monetary Fund, India's Gross NPA and Restructured Loan ratio together amounted to a little over 12 per cent of all outstanding credit by March 2018. The RBI's projections suggest that NPAs will mount through FY 2018-19.  The RBI has consistently underestimated NPA generation under its "stress test scenarios".  Since stress has increased due to the falling rupee, it's likely that NPAs could mount considerably. 

The banking crisis is contributing to slower growth. Even if corporates wish to borrow money to carry out capacity expansions, banks with shattered balance sheets cannot lend. Moreover, banks are in no position to cut lending rates to try and induce faster credit expansion. 

When it comes to individual banks, the government plan of merging weaker banks with stronger ones may, or may not, work. The Bank of Baroda, Vijaya Bank and Dena Bank merger could eventually create a healthier entity. But take a look at SBI after the merger of all the associates – it's been over a year, and the combined balance sheet is still nothing to write home about. 

There's a truism that a crisis in the financial sector causes more long-term pain than a crisis in any other sector. Well, India has experienced a banking crisis for several years. Although the RBI is acting tougher, it doesn't have the leverage to meaningfully change the way in which the PSU banks operate. There's still no light at the end of the tunnel.