Last week, Reserve Bank of India Governor Raghuram Rajan indicated that the non-performing asset (NPA) problems of the Indian banking system were far from over. While widely perceived to be the case, the governor's acknowledgement of the problem brings it on to centre stage as a potential crisis. Even as the economy is showing some signs of recovery, the capacity of the banking system to support the process should raise serious questions. A recent report by CRISIL lays out the magnitude of the problem. It estimates that gross NPAs will rise by almost 20 per cent to Rs 4 lakh crore during the current fiscal year. As a ratio to total assets, they will increase by about 20 basis points to 4.5 per cent. The report also estimates that "weak" assets, which include NPAs as well as some proportion of restructured assets, will come in at Rs 5.3 lakh crore during the year, about six per cent of total assets. Overall, it presents a rather gloomy picture of the state of the country's banking system, aggravated by the fact that these negative trends are expected to prevail in a generally improving macroeconomic environment. Within the sector, public sector banks are generally worse off than private sector ones.
There is little mystery about why the problem is so acute. The primary cause of bad assets is the massive burden of infrastructure projects that are stalled and, therefore, unable to service their due obligations to banks. While the government has expressed good intentions about improving conditions in the sector, it has yet to implement any meaningful strategy. Unless a concerted effort is made to revive activity in these projects, so that banks can look for exit opportunities, the problem is not likely to go away. While carrying the burden, banks are, quite logically, constrained from taking on any additional risk, which means that they are reluctant to lend to even their conventional customer segments. The steady deceleration in bank credit is a pointer to this constraint and, as indicated above, poses a significant risk to any revival in economic growth.
There are no easy solutions to this problem. Re-capitalising banks has been proposed and may be part of a composite approach, but by itself really only means throwing good money after bad. More and more capital will be consumed by provisioning against bad assets rather than by credit expansion. The pressure is compounded by the mandate to achieve Basel-III capital adequacy benchmarks over the next four years. Not only will internal accruals be woefully inadequate, external investors will be extremely wary of providing funds to banks whose asset portfolio will remain fragile for some time to come. A strategic response to the problem needs to be in two phases. The first phase will involve the unloading of a significant chunk of the bad assets in infrastructure from the books of banks on to a special purpose vehicle - a "bad bank" as some call it. The second phase can then focus on re-capitalising public sector banks, with a combination of public and private funds. Given the government's decision to be selective in channelling funds to banks based on financial health, this may also require consolidation. Time is of the essence.
