Daily Editorial Update – NPA problem: Bankers alone should not be blamed

There has been significant debate
on the NPA problem in India. While the regulator has done well to enforce NPA
recognition through asset quality reviews, let us take a step back to analyse
why NPAs happen. Unless we address this aspect, it will be a perennial hole in
the bucket for the banking industry. While several individual NPAs can be
attributed to poor credit judgements or failure of good process by bankers,
let’s go beyond that to more thematic reasons.

Often there is talk of crony
capitalisation leading to corruption in banks, and consequently the NPAs. A
decade ago, an unnamed individual walked up to me at an event in Delhi and
introduced himself as a “power broker”. Intrigued, I asked the gentleman what
he did. His answer was: “I connect the needy with the greedy!” Red alert – I
walked a mile away! And yet contrary to the aforementioned perception, I would
say that the Indian banking industry is not corrupt – 99.9% of the Indian
banking industry is manned by honest, middle-class individuals with good values.
This is not where the answer lies for most of Indian banks NPAs.

What did cause NPAs globally was
the sharp contraction in capacity utilisation and output prices since the
global financial crises, resulting in some global businesses — commodities etc
— becoming deeply stressed. Although India is not alone, a lesson for banks is
simply that stress analysis must incorporate deeper and more volatile cycles,
and look beyond the shores of the country. Global banks may be better placed,
as the commodity and derivative markets provide hedging possibilities, which
unfortunately may not be as easily available to local banks.

Another less discussed reason for
NPAs in banks, globally, relates to banks’ board role towards setting the right
business framework. Regulators can do only so much to raise the red flags. Bank
boards need to be more assertive in their choice of the business model, credit
policies and consequences of management’s actions. In recent times, global bank
boards have been more demanding on banks’ CEOs than local bank boards,
exceptions apart, of course.

One significant reason for NPAs
has been Indian banks’ focus on security, rather than projected operating cash
flows, in their credit assessments.

This is surprising as India has a
legal environment where security invocation is highly delayed and often
uncertain. It’s not Indian banks alone. Some foreign banks also got burnt with
concentrated exposures to corporate group holding companies, with unrealisable
illiquid share collateral. Cash flow based lending becomes even more critical
in the asset light digital world of today.

In the last decade, some
infrastructure projects did suffer due to policy paralysis around environment
and related approvals.

To add to that, some industrial
sectors were impacted as auctions brought fair pricing and transparency into
the transfer of assets. While no NPAs are good NPAs, these are exogenous
factors to bankers’ credit assessment, and hopefully are one-time events, as
India, rightly so, cleanses itself.

Having spent 30+ years in banking
across USA, Asia Pacific especially India, I can confidently say that the “made
in India” bankers are very good. Especially junior to mid-level bankers from
the public sector who have been trained cross-functionally at the grassroots
level. However, one suggestion. Perhaps regulators need to force bankers to
have periodic certification by a self-regulatory organisation, to help address
the knowledge gap that often results in unintended credit and regulatory
breaches.

Coming back to growing NPAs,
another reason has been the relative absence of deep bond markets. This has
implications for bank NPAs in two ways.

Firstly, there has been an
over-concentration of long-dated infrastructure-related project finance
exposure on the banking system rather than it being diversified across banks,
bond markets, pension funds and insurance companies. Secondly, banks may have
mispriced these loans in the absence of any market-traded credit benchmarks.
Cheap long term loans have the least financial incentive to be paid back.

Much has been documented on what
ails the public sector banks. A smaller public-sector bank deriving comfort
from collective action of other public sector banks to justify grant of a loan
is most often the wrong reason to lend. And the same comfort in collective
action could slow down their NPA resolution on the way out. The Banks Board
Bureau can play a critical role in this. Strategic reforms will no doubt
consume significant political capital but it is the oxygen, and it is needed
urgently. Thankfully, the government seems to be fully committed to the above.

Finally, much has been written on
the slow and antiquated laws on bankruptcy, which unfortunately delayed the NPA
resolution and recapitalisation process leading to mounting gross NPAs. I am
glad the Finance Minister has impressively delivered on legislative reform on
this front, which will definitely show results in 2018 and beyond.

In conclusion, on a positive
note, with India’s government and regulatory focus on financial inclusion, the
journey ahead will provide even more bankable opportunities than unbankable
risks. The rush of global liquidity chasing Indian banks, NBFCs, micro-finance
companies, AIFs and housing-finance companies is quite unprecedented, and not
surprising. The best is yet to come, especially if India, under Prime Minister
Modi, grows consistently in the 7-8% band for the decade ahead.

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