The Indian economy is facing one of its simmering troubles in a banking system weighed down by bad loans. For an economy that is growing at a tremendous pace, there exists a high distress among various public sector banks (PSBs) which have written off a total of Rs 1.14 lakh Crore of bad debts between FY2013 and FY2015. The huge degree of subprime lending by 29 PSBs shows the instability that exists in the market and the need to have a comprehensive reform of structure and processes. Before explaining the fraud that has taken place, let us give you a brief introduction of what bad debts are all about.
What is Bad Debt?
Bad debt is the debt that cannot be recovered. It is not collectible and therefore not worthy to the creditor. Bad debt is usually a product of the debtor going into bankruptcy or where the additional cost of pursuing the debt is more than the amount the creditor can collect.
Writing-off of a bad debt implies a reduction in an asset’s value or earnings by the amount of an expense or loss. It is done primarily to gain tax benefit on the written-off value. It is usually done to “clean” the balance sheet and achieve taxation efficiency.
The Recent Muddle: Mounting Bad Debts
29 state-owned PSBs have written-off a total of Rs 1.14 lakh Crore of bad debts during FY2013-15, much more than that in the preceding nine years. Bad debts rose from Rs 15,551 Crore in end-March 2012 to Rs 52,542 Crore in end-March 2015. Only two banks namely State Bank of Saurashtra and State Bank of Indore have displayed zero bad debts in the past five years.
The State Bank of India (SBI), India’s largest bank and Punjab National Bank (PNB), India’s second largest bank both witnessed large proportions of bad debts thus displaying sharp fall in profits. For SBI, amount of bad debts increased by almost four times since 2013 from Rs 5,594 Crore (2013) to Rs 21,313 Crore (2015). It accounted for almost 40 per cent of the total bad debts written-off by all the banks in 2015. In the case of PNB, bad debts grew by 95 per cent during 2013-14 and 238 per cent (from Rs 1,947 Crore to Rs 6,587 Crore) in 2014-15.
According to data shared by the Reserve Bank of India, bad debts grew at 4 per cent during 2004-12 while they grew at almost 60 per cent during FY2013-15. Between 2009 and 2013, amount of bad debts written-off doubled from 0.33 per cent to 0.61 per cent since 2013. Banks have written-off bad debts amounting to almost 85 per cent of the loans. Also, the total written-off value between 2004 and 2015 amounts to more than Rs 2.11 lakh Crore.
Currently, non-performing assets (NPAs) form 17-18 per cent of the total assets of PSBs. Gross NPAs have risen to 6.03 per cent in June 2015, from 5.20 per cent in March 2015. Also, according to Mr. Jayant Sinha (Minister of State for Finance), the stocks of stressed assets is roughly Rs 8 trillion ($117 billion), and the Government has committed cash for this. Government-controlled lenders will require infusions of 1.8 trillion rupees in equity according to Basel III norms.
Steps Taken Till Date
The Supreme Court of India (SC), on 16th February 2016, directed the Central Bank to furnish details of defaulters with debts above Rs 500 Crore. The Government is taking steps under the SARFAESI Act (Securitization and Reconstruction of Financial Assets and Enforcement of Security Interest Act) whereby banks can recover loans in cases where Non-Performing Assets (NPAs) are backed by securities charged to the bank by way of hypothecation or mortgage or assignment.
Dr Raghuram Rajan (Governor, RBI) is looking after ways to ensure that banks classify certain assets as NPAs and make adequate provisions to strengthen their balance sheets, besides working out schemes of Mergers and Acquisitions (M&As) which can optimize the use of resources. He has assured investors that a clean-up of balance sheets is underway to restore the economy and has therefore set March 2017 as the deadline to clean up balance sheets. He has also guaranteed enough cash availability to revive PSBs but at the same time has cautioned that this might lead to a decline in the short run profits for some PSBs.
Last year, the Indian Government announced ‘Indradhanush’, a plan to infuse Rs 70,000 Crore in PSBs over four years, while the remaining Rs 1.1 lakh crore can be raised from the markets to meet their capital requirements in line with Basel III norms. According to the plan, the banks will receive Rs 25,000 Crore (of the total Rs 70,000 Crore) this as well as the next fiscal while the remaining Rs 20,000 Crore will be distributed equally in the FY2017-18 and FY2018-19. Of the Rs 25,000 Crore set for the current fiscal, the Government has already infused about Rs 20,088 Crore in 13 PSBs.
The Road Ahead
The Indian Banking Sector requires major restructuring to revive growth and recover from the big fraud that has occurred in the banking industry. The major reasons to bring in reforms are as follows:
- Rapid technological advances in the financial services sector. For example- PayTm handles greater transaction volumes than any other bank.
- Greater competition due to increase in the number of banks and a more differentiated pattern of banking, aimed at widening and deepening financial inclusion.
- Large number of General Managers (GM) due for retirement in the current financial year due to the hiring freeze in the 1990s. By 2020, the number of employees in the PSBs will fall greatly. Also reduced profitability of the PSBs and inability to hire laterally as well as comparatively poorer remuneration imply poor fresh recruitment.
Also, given the poor health of the banking sector, the upcoming Union Budget 2016-17 requires pushing forward the growth of PSBs through accelerated bank recapitalization and measures to prevent recurrence. If the Government is not able to revive the sector, banks will fail to restart lending in earnest, undermining hopes of a sustained period of near double-digit growth.
The Government is right now addressing both the problem of delays in investment project and providing more capital. It will put $11 billion into PSBs by 2018, while the banks are expected raise $17 billion more from investors or by selling assets. In addition, reforms including plans for a new bankruptcy law to help banks get assets back are planned to be introduced. A new national investment fund with $2.9 billion in government seed capital is also planned.
In long run, more radical changes may be necessary. M&As including large PSBs acquiring smaller ones those are unable to raise capital or invest in new technology. This could allow large banks to grow globally along with the growth of the Indian economy. Apart from M&As within the public sector arena, acquisition of PSBs by private bank is also another way to bring growth in the banking sector.
Dr. Rajan is in favour of establishing bad debts companies. These companies purchase the loans which borrowers are unable to pay at sharper discounts. These companies then take the onus of following the borrowers and convincing them to offer something in return of non-payment of the loan amount.
Thus, proper intervention (by providing cash), bringing in reforms for restructuring and improving upon the visibility and transparency on stressed assets are required for strengthening the banking system. It is only with the establishment of better laws and structural reforms will the country be able to achieve stability and revival in the economy.
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