By Spandan Pattanaik

Introduction:  

Credit creation for economic activities is the prime function of any bank.  Apart from raising resources through deposits, borrowing, recycling of funds constitute major part of its activity. Lending is encouraged because it helps the economy to expand. However the process carries a risk ,called the credit risk which may arise due to the failure of the borrower. Non- recovery of loans, either  principals or interests forms a major hurdle in the process of credit cycle, and affects the bank’s performance. Non-performing assets (NPAs) have emerged as a alarming threat to the banking industry and it is sending distressing signal on the sustainability of the banks. As per Economic Survey 2015-16 the Gross NPA of Scheduled Commercial Bank as a proportion of Gross Loans were 5.5 % by Sep 2015. The Net NPA rose from 2.5 % to 2.8 % from March to Sep 2015. As per Economic Survey 2016-17 Net NPA is  9.6 Lakh Crores at the end of Dec 2016. Similarly there is an urgent need to bridge the gap between the government and central bank that has arisen due to the difference in opinion on various issues such as dividend distribution, policy rate determination, appointment process etc.

Causes and Effects : An Analysis :

During the boom period, i.e. mid 2000, the world economy was doing with a growth rate of 9 to 10 % . Majority corporate assumed that the growth was a result of the economic reforms of India of the 1990s. Companies started investing in various projects such as infrastructure, highways real-estates etc. Investment further increased due to the relaxed lending norms especially for corporate houses when their financial status and credit rating was hardly analyzed during the lending process. So the boom period credit disbursal was associated with very less stringent credit appraisal. Another factor is accelerated credit growth, resulting from competitive credit disbursal encouraged by the sharp decline in the statutory liquidity ratio (SLR) from 30.5% of total assets at end March 2005 to 22.6% at end March 2008. To survive in the competition banks started selling unsecured loans. Corporate and banks both followed the same model despite of a fear of formation of bubble having a thought that there is unlikely that majority can be wrong.

Even if they were convinced about the risk, they still believed in a particular idea because majority follows it and there is a sense of assurity. In economic terms this is called Herd behavior or Bandwagon Effect. It is an tendency of people to align their beliefs and behaviors with those of a group is also called a Herd mentality.However it was never realized that we had to pay a lump sum amount in a long run.  Soon due to the global crisis, international demand as well as the local demand fell down in various sectors including aviation and Information Technology. Profit of most of the firms diminished due to slowdown in the global economy, ban in mining projects, delay in environmental related permits affecting power, iron and steel sector majorly, volatility in prices and shortage of availability of raw materials. Five sectors – Textile, aviation, mining, infrastructure contributes to most of the NPA, since most of the loan given in these sector are by PSB, They account for most of the NPA. Most interestingly, their share of gross NPA of top 100 large borrowers rose 22.3% in March 2016 from 3.4% six months ago.

If we analyze sector wise, the capital-intensive steel industry is considered the largest contributor to the overall non-performing assets (NPAs), . As per an article titled -‘Steel industry is the largest contributor to the banking system’s overall NPAs’ – the aggregate debt of the five steel companies stood at ₹1,48,289 crore at March-end 2016, and a stressed advances ratio of 45.8 per cent for March 2017. Another major irritants in the of Indian steel industry has been the poor record of repayment of loans taken from the banks and other financial institutions and these problems are  further aggravated by dumping of steels by China. Similarly, traditionally, India’s textile sector not only employed millions of people directly but also opened India’s gate to global trade. However, things have changed, textiles mills are shutting down and new jobs aren’t being created as exports are getting affected. The countries such as Bangladesh and Vietnam have left India far  behind in their race to the top. India’s textile exports declined marginally last year to $36.26 billion from $37.14 billion recorded in the year 2014-15.

These factors led to price wars in various industries majorly aviation and telecom i.e. predatory pricing. Although government tried to control the situation through fiscal stimulus, but rupee got weakened.

The misfortune is compounded by the fact that there is an open nexus between the politicians and the business community. Crony Capitalism and Favouritism are major issues and many business loans get passed due to close relationship between the business officials and the bank officials . Various study says that in the past two decades, giant lenders especially the public sector banks were very busy to appease the government who acted as their promoter. After two rounds of nationalization in 1969 and 1980 the state run banks extended their arms and exploited their balance sheets for populist goals. Very little attention was paid to the quality of the assets. Sometimes, with the new government or boards of member of the bank, banks gets new policies for operations which makes the task difficult to tackle with the NPAs. The majority of the share of NPA is in public sector banks. Decisions were taken without thoughtfulness or rationality. Banks granted loans without following the procedure and it continued for long. So Habitual Decision making is another major cause for banking crisis.

Effects :

Its effects are manifold and widespread which can be seen from institutional to individual level.  Increased NPA level is likely to have an adverse impact on the bank business as well as its profits, shareholders value of money may get eroded. It is further responsible for lowering the confidence and credibility of the banking system resulting trust deficit. People withdraw money and this event may have cascading effect on all importance ratio of the banks viz  Profitability, Dividend Payout, Net Interest Margin, Return on Assets, provision coverage ratio, Credit contraction etc.

Banks to avoid stress on their balance sheet, over invest their net demand and time liabilities in G-Security which are less risky. So the high level of stressed asset encourage Public Sector Banks to overinvest in risk free G-sec to maintain risk weighted Capital Adequacy Ratio and to comply with “Basel-3” Norms. So since banks also gets less return by investing in government securities they are not expected to give more interest to the customer deposits. This results in diversion of investment towards non-productive assets such as Gold ,land and other assets , as the consumer thinks it’s not the right time to park money in the bank. Further it aggravates the problem as there is a sharp decline in the deposits of the banks due to this event  and the entire cycle of borrowing and lending process gets affected.

There are Negative spillover due to the decrease in deposits. Bank’s main source is deposits.When the deposits in the Bank declines, Banks are not expected to decrease the borrowing cost (i.e rate of interests) even if RBI decreases the repo rate. Companies postpones their investments and so the growth rate will decline and it will lead to inflation and unemployment, if not stopped. As bank’s reliable source is term deposit. So any slow-down in time deposit will hamper the credit lending capacity.

On one side this event puts additional stress on the current account and on the other hand it also affects the savings of the households. If it continues for a long,  it increases the current account deficit of the country and as a result of which Rupee gets depreciated. However on the positive side this event is the rise in foreign investment as the sovereign rating would look good.

RBI versus government :  Sometimes Government’s policy becomes hindrance to the policy transmission. Repo rate was cut by 125 basis points from Dec-2014 to Dec-2015  but scheduled commercial banks cut the interest rates by 43 basis points during the same period . It was primarily because of the small saving instruments. Hypothetically lets us assume that the deposit rate is 7.3% and base lending rate is 9.30% with a margin of 2% for the banks operation. RBI decreases its repo rate i.e. 9.30 % to 8.30 % and banks responded by decreasing its borrowing rate by 1 percent. But to maintain the same margin of 2%, it will be compelled to decrease the deposit rate of  by 1 percent i.e. from 7.30% to 6.30%. This results in competition with other saving instruments which provides more interests rates than the banks.

Similarly there is another area which can be very controversial i.e. RBI’s role to control the inflation and debt management. The Reserve Bank of India Act 1934, has empowered the central bank to manage the public debt incurred internally by way of selling various types of instruments. The Government’s worry is that as a manager of debt, RBI will have to sell the Govt bonds cheap to reduce interest burden on the Govt. Where as a monetary controller it should tighten the rates to contain inflation. This creates conflict in interests. The RBI which operates according to Reserve Bank of India Act of 1934 has an obligation to allocate surplus funds to the centre. The RBI mainly earns its profits from the interest it gets from the sale and purchase of government securities, the interest earned from lending to banks and an interest earned on open market operations etc. Special dividends to the government don’t really help the government with its budgetary constraints because much of the surplus that RBI make comes from interest it get on government assets or from the capital gains that  RBI makes market participants. When RBI pay this back to the government as dividends. It means that it is putting back into the system the money RBI made from it there is no additional money printing or reserve creation involved. This will not resolve the problem of inflation.

The method of determining the policy rates have always remained controversial. Majority of the time government advocates to bring down the policy rates, which may not be feasible in the long run. RBI in order to maintain the inflation, balances the interest rates. So there is a  difference in opinion between the government and RBI. Also in the present method of monetary policy, government has a stake in deciding the rate, which can sometimes lead to interference in the RBI’s territory.

Majority of the decisions taken by the banks are influenced by the government. The appointment process of governor of central bank is more political and less on merit with no clear indication of the tenure. A longer tenure is necessary as India is moving to a new rules based monetary framework and so stability is decision making is necessary.

Recommendations:

First of all, morality should be separated from Non Performing assets. It should be understood that every defaulter is not a wilful defaulter, loans can become bad loans due to the bad luck of businessman, regulatory clearances etc. So, entrepreneurial wealth is not sinful and if the entrepreneur is not a will full defaulter, yet tarnishing his image would led to loss of reputation, insecurity in the market and economy will not get right kind of investors in the future.

Entrepreneurs will shy away from taking risks. So growth and job creation may get affected

in the long run. Restructuring of loans logically and scientifically is  necessary. RBI should direct the banks ,not to wait till a loan gets into NPA category, rather track them much before to know if there is any default in payment of interest or loans. Joint lenders forums should be formed and more power to deal with wilful defaulters.

There is a need for behavioural change both from institutional level to individual level. So moral suasion is necessary through various instruments such as seminars, conferences, panel discussions etc. If this does not work, RBI should go for the policy of publicity, like publishing weekly statements  of assets and liabilities etc. This can bring more transparency and moral pressure erring banks no to violate norms. So banks start abiding by the credit control measures. If that does not work then Central bank can take action under the Banking Regulation Act 1949 which gives power to RBI .

There should be a debt management agency to manage the internal and external debt of the government as per the international best practices. Such a Public Debt management agency should be given statutory rights. Bond market should be deepened and regulations should be passed in this respect. 5 years term for the governor will be more consistent with both the political cycle and inflation cycle. This will provide an independence to the Monetary Policy Committee. There should be protocols and rules predefined for the interaction between various ministries and the central bank of India and every meetings should be recorded and  codifications of document etc are necessary to avoid the problems related to crony capitalism etc. Similarly it should regulate such small saving schemes, and make arrangement for effective transmission of monetary policy.

Conclusion:

From the above essay it is observed that both internal and external factors are responsible for this crisis like situation. Internal Factors includes diversion of funds for Expansion, diversification, modernization, business failure, inefficiency in management, inefficiency in credit management and monitoring, lack of coordination among lenders. In the External front recession i.e. global slowdown, price escalation, exchange rate fluctuation, changes in government policies in excise/ import duties, pollution control orders, etc and some other factors also affected the banks balance sheets. The problem of NPAs in the Indian banking system is one of the foremost problems that had impact the entire banking system. Higher NPA ratio trembles the confidence of investors, lenders, depositors etc. It also causes poor recycling of funds, which in turn will have deleterious effect on the deployment of credit. The non-recovery of loans affects not only further availability of credit but also financial soundness of the banks.

But it is also true that India has carried its banking system to the remotest part of the country and has played crucial role in financial inclusion. It has been successful in creating sound credit and monetary policies keeping development agenda in mind. It has also has brought stability to the banking system by striking a balance between various sectors like agriculture, industry, services and export sector. So it has proved itself as the prime mover of economic growth and development in India. It has also been able to manage our foreign exchange at all time high at 360 bn $.

So, government should pay due regard and attention to this issue for a stable  economics and there should be sync between the fiscal and monetary policies of a country with both Finance Ministry and RBI on the same page to achieve the historic 10% growth rate.

References :

-Economic Survey 2014-15 Government of India.

-Economic Survey 2015-16 Government of India

-Economic Survey 2016-17 Volume  1 , Government of India.

-Financial Stability report , Reserve Bank of India , Issue No 13,June 2016

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• Article “Infrastructure, metals and textile sector have contributed most to the stressed loans “, June 2016

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Spandan Pattanaik  is a second year Masters’ student at Jindal School of International Affairs.

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