Context: Non-performing assets (NPAs) at commercial banks amounted to ?10.3 trillion, or 11.2% of advances, in March 2018. Public sector banks (PSBs) accounted for ?8.9 trillion, or 86%, of the total NPAs. The ratio of gross NPA to advances in PSBs was 14.6%. These are levels typically associated with a banking crisis.

What caused this?

• The credit boom of the years 2004-05 to 2008-09. In that period, commercial credit (or what is called ‘non-food credit’) doubled. Indian firms borrowed furiously in order to avail of the growth opportunities they saw coming. Most of the investment went into infrastructure and related areas — telecom, power, roads, aviation, steel. Businessmen were overcome with exuberance, partly rational and partly irrational.
• Problems in acquiring land and getting environmental clearances, several projects got stalled.
• At the same time, with the onset of the global financial crisis in 2007-08 and the slowdown in growth after 2011-12, revenues fell well short of forecasts. Financing costs rose as policy rates were tightened in India in response to the crisis.
• The depreciation of the rupee meant higher outflows for companies that had borrowed in foreign currency.
• This combination of adverse factors made it difficult for companies to service their loans to Indian banks.
• The Reserve Bank of India (RBI), acting in the belief that NPAs were being under-stated, introduced tougher norms for NPA recognition under an Asset Quality Review.

Impact of higher NPAs:

Higher provisions on the part of banks. Provisions rose to a level where banks, especially PSBs, started making losses. Their capital got eroded as a result. Without adequate capital, bank credit cannot grow. Gross NPAs/advances rose sharply.

Why high NPAs in public sector banks?

PSBs had a higher exposure to the five most affected sectors — mining, iron and steel, textiles, infrastructure and aviation. These sectors accounted for 29% of advances and 53% of stressed advances at PSBs in December 2014.

What needs to be done?

• One immediate action that is required is resolving the NPAs.
• An alternative is to set up a Loan Resolution Authority, if necessary through an Act of Parliament.
• The government must infuse at one go whatever additional capital is needed to recapitalise banks — providing such capital in multiple instalments is not helpful.
• Over the medium term, the RBI needs to develop better mechanisms for monitoring macro-prudential indicators.
• Actions needs to be taken to strengthen the functioning of banks in general and, more particularly, PSBs. Governance at PSBs, meaning the functioning of PSB boards, can certainly improve.