An increasing number of observers are veering round to the view that the asset quality position of Indian banks could be the last straw that breaks the economy's back. In the year that the government has been in office, nothing significant has been done to deal with what is clearly emerging as a critical problem. If the weight of outside observations was not enough, the Reserve Bank of India (RBI) has emphasised the significance and urgency of the problem in its six-monthly Financial Stability Report, which it published last week. The report is intended to draw attention to an entire range of potential threats to financial stability, global or domestic. On the global front, the risks of unanticipated monetary actions by central banks in the advanced economies are pointed out. But given the steps that India has taken to narrow its current account deficit, the vulnerability is moderate. By far, the most significant risk raised in the report is the state of the Indian banking sector, particularly the public sector banks.
There is graphic evidence in the report of how quickly and by how much the significance of non-performing assets (NPAs) in the banking system's balance sheets has increased. For public sector banks (PSBs), gross NPAs, including re-structured assets, rose from a little over six per cent of total advances at the end of 2010-11 to almost 14 per cent by March 2015. With all the provisions that were made during this period, net NPAs for this group rose from about one per cent to about three per cent. But it must be remembered that provisions divert capital from supporting business expansion. Given the seemingly unstoppable trend, it is no surprise that banks are extremely reluctant to lend any more. Credit growth is the slowest it has been for decades. The report also points out that five sectors - mining, iron & steel, textiles, infrastructure and aviation - together accounting for 29 per cent of PSB advances, contributed 53.1 per cent of their NPAs. Infrastructure alone represented 17.6 per cent of advances but 30.9 per cent of bad loans. This picture was not too different for private and foreign banks.
Against this rather bleak backdrop, the challenge of enhancing PSB capital assumes gargantuan proportions. Already faced with the targets set by Basel-III compliance, the diversion of capital into provisions against bad loans is further complicating the process. And the government appears to be taking no visible steps to stem the rot. Simply infusing more funds, as the finance ministry appears to be inclined to do now, will not solve any of the problems. NPAs are an open wound, from which the bleeding needs to be stopped before more capital is transfused. Otherwise, it will also drain out, doing nobody any good. The restructuring of banks, both financially and organisationally, must be given top priority; without this, none of the other initiatives of the government has any prospect of succeeding. There are no indications, either from the RBI or anywhere else, that the situation will rectify itself.
