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July 27, 2012

Level of NPA's Reasons for NPA

The bad loans of public sector banks grew by a whopping 56% during 2011-12.

On the face of it, it appears as if public sector banks (PSBs) have managed to keep their head above water in the past year. However, a closer look reveals that their operations are dangerously vulnerable to the economic uncertainties in India today. After eliminating the last minute window-dressing by banks, deposit growth looks halting and growth in advances below par. However, the shocker is the whopping increase in their non-performing assets (NPAs) which reflect the health of a bank’s asset portfolio. Here are the numbers. While the total loans and advances of public sector banks grew by 17.37% during 2011-2012, their gross NPAs increased by a huge 56.95%. This is nothing short of daylight robbery. If NPAs of public sector banks gallop at this rate, it will not be long before many PSBs return to being deeply in the red. Central Bank of India, dogged by a series of controversies over actions and decisions of the past two chairmen, has already earned the ignominy of declaring a net loss of Rs105 crore in the 31 March 2012 quarter, as against a net profit of Rs132 crore during the corresponding quarter of the previous year—a sharp reversal of its situation.

In banking, loans going bad are part of the business risk; NPAs are inevitable, but they should remain within limits. A bank’s lendable resources are mainly public deposits and, unless these deposits are profitably deployed with proper checks and balances to keep NPAs low, a capsizing bank can cause systemic banking failure. NPAs have to be taken seriously because loss-making banks are inevitably bailed out and capitalised with the taxpayers’ money in India. There is another major issue that most analysts miss—banks are allowed large write-offs against NPAs which reduce their tax liability. Lower taxes paid means fiscal stress that has to be borne by taxpayers either as inflation or by higher tax rates. Preventing a further downgrade of their credit rating is important not only from the perspective of retaining public confidence but also the impact it has on the bank’s resource-raising cost. As India remains mired in poor economic growth, where are we on the issue of bank NPAs?

The following two tables give details of the growth of the advances portfolio and the corresponding rise in gross NPAs of all the public sector banks (first table) for and private sector banks (second table) for the year ending March 2012. A quick look would reveal that there is a marked contrast between the performance of PSBs and private banks. Although the total advances of private sector banks were less than 25% of those of PSBs, private sector banks, as a whole, have done better on the NPA front. This is reflected in the significantly higher valuation of their shares on the bourses

It is clear that performance of the PSBs has deteriorated considerably during the past year.
Indeed, the private sector banks have, in fact, improved their position over the past two years. If credit growth slows down during the current year, the position of PSBs will worsen, unless banks are able to recover or upgrade a substantial part of their existing NPAs. Mind you, this position is after writing off substantial NPAs as being irrecoverable last year.

Besides NPAs, every bank has a sizeable portfolio of restructured advances, not included in the NPAs at present. Restructured advances are those that were prevented from being classified as NPAs by rescheduling them by giving extended holiday for repayment of loan instalments as well as interest to give the borrowers some more time to meet their commitments. Until 2001, these restructured accounts were considered NPAs, but to provide reprieve to banks and borrowers, the Reserve Bank of India (RBI) magnanimously took a decision to permit these loans to be treated as standard so long as they were rescheduled before becoming NPAs. Banks were allowed to do this if they considered the projects to be viable and believed that the cash flow problems faced by these borrowers were temporary. This amounted to the regulator’s nod to ‘ever-greening’ of loans and officially postpone the problem. More often than not, a sizeable chunk of these loans becomes non-performing—RBI officials themselves concede that 15% of restructured assets become bad debts.
As on 31 March 2012, restructured advances of State Bank of India (SBI) alone grew to Rs37,168 crore. This helps to camouflage the ugly face of the Bank’s performance, fools investors and creates a false sense of complacency. If you add up SBI’s NPAs and restructured loans, it is a massive Rs76,849 crore which is over 91% of the total net worth of the Bank!

The obvious question is: Why do PSBs suffer from this malaise? They point out to sluggish economic environment which makes loans turn sticky. But this is only an excuse; private banks have performed better in the same environment. Indeed, they have improved their gross and net NPA ratios. Another excuse trotted out by PSBs is the use of technology: that shift to core banking solutions led to higher reported NPAs! Does this mean that the banks were deliberately suppressing NPAs so far? Does it also mean that auditors (and RBI inspectors) were sleeping or certifying false disclosure of NPAs without verification? The problem is endemic. The way PSBs operate inevitably leads to several functional deficiencies:

1. Credit assessment in PSBs is inadequate. Decisions with regard to large value loans usually get clouded by internal and or external pressures. It is often said that the large value loans in PSBs are often fixed in advance—much like match-fixing. This puts public resources at risk for the personal gain of industrialists with political clout. The ‘cash for loan’ scam unearthed last year revealed how this works. Most loans that are granted under (political or corporate) pressure often turn into NPAs within about a year. RBI should, therefore, ask each bank to make an independent study of all large-value loans that have turned non-performing within a year and investigate each of these cases to ascertain whether there was any violation of the laid down norms and regulations. A periodic inspection by an outside agency will serve as a deterrent and prevent the operating staff from deviating from prudent principles.

2. Keeping a close watch on the end-use of funds is the most important role of the banks’ operating staff, since any misuse of funds leads to default. While this is the primary responsibility of branch offices, the central office cannot absolve itself of the responsibility. Most often, financial mismanagement by borrowers results in loan default. If bank branches take cognizance of the symptoms of financial difficulty, such as dishonour of cheques for lack of funds, delayed submission of stock statements, etc, many accounts can be saved from turning into non-performing ones.

3. All large branches of PSBs are brought under concurrent audit as per the guidelines of RBI, at substantial cost; but the contribution from these concurrent auditors in identifying and reporting potential NPAs is poor. It is necessary to widen their role and responsibilities and make it mandatory for concurrent auditors to examine in depth the utilisation of loan proceeds in all large value accounts and their operations, and report to the board of directors where an RBI nominee is ever-present. This will help banks initiate corrective steps long before the account goes bad.

4. There are generally two types of recalcitrant borrowers and banks do categorise them as such in their records. The first is an unintentional defaulter, who becomes sick due to factors beyond his control. The second one is a wilful defaulter, who, by mismanagement or intention, makes his company sick and seeks all sorts of concessions from the bank. In such cases, it can often be seen that the company turns sick but the promoters remain healthy and lead a life of luxury. Unfortunately, the Companies Act currently does not allow lenders to remove wilful defaulters from the management. Banks remain silent spectators to such loot. It is desirable that the names of all wilful defaulters be put on the website of RBI, so that they are exposed and ostracised by the banking community.

5. In the United Kingdom, once a company’s net worth turns negative, it is considered insolvent and its directors become personally liable for all the actions (from that day), if they continue in the management. Usually, the directors resign immediately and hand the company over to the lending bank which, in turn, appoints an administrator until it is sold through a public auction. This ensures that the company survives and banks realise their dues. In India, this was done only in the case of Satyam Computers after its promoter Ramalinga Raju admitted to fraud. There is a need to introduce legal provisions in our Companies Act so that the entire hoax of companies becoming sick and carrying on business from the comfort of a five-star hospital called BIFR (Board for Industrial and Financial Reconstruction) for years together at the expense of the exchequer is put an end to. The ministry of corporate affairs should include these provisions as in the UK Companies Act in the revised Companies Bill under the consideration of our government.

6. The introduction of The Securitisation and Reconstruction of Financial Assets and Enforcement of Security Interest Act, 2002 (SARFAESI Act) has helped banks in improving recovery of dues. However, borrowers can obtain stay orders from higher courts and prevent banks from enforcing the securities. This leads to delays of several years.
Meanwhile, moveable securities charged to the bank slowly disappear and operations come to a standstill. The government must stipulate a maximum limit of, say, six months for the higher courts to dispose cases filed under the SARFAESI Act to ensure that projects are still viable when sold. However, the fact that NPAs have ballooned even after the SARFAESI Act, shows that banks are not known to invoke the Act quickly and effectively against those borrowers who bring political pressure to bear or obtain loans by dubious means.

7. Debt Recovery Tribunals (DRTs) are specialised courts for speedy disposal of recovery cases filed by banks. There are 33 DRTs in the country with as many as 67,000 cases involving over Rs1,36,000 crore pending before them as on 31 March 2012. The finance minister, while addressing the presiding officers of these DRTs recently, expressed concern over the large pendency of cases and asked them to suggest ways to unlock banks’ resources. While there is an urgent need to set up more DRTs in tier-II cities and fill up the existing positions (several DRTs are headless), to ensure that cases are disposed of within two years, the fact is corruption has affected DRTs too. Cases are deliberately dragged on either due to the interests of the parties or simply incompetence of the judges, giving the impression that DRTs are overloaded with work. If the speedy disposal of cases makes some of this disputed Rs1,36,000 crore available to the banks within the next two years, the government will not have to pump additional capital into banks. This will save taxpayers’ money and bring down fiscal deficit substantially.

8. The appointment of chief executive officers (CEOs) of PSBs is a game of musical chairs. Selection is either without application of mind or due to political lobbying. Many continue to be appointed for a term of around one year. A chairman appointed with a 12-15-month tenure ends up spending six months to understand the bank’s culture and the remaining period in making retirement plans. This includes lobbying for post-retirement government sinecures or seeking lucrative private sector directorships. What is the incentive for such CEOs to be involved with the bank in any constructive manner? The government should ensure a minimum tenure of three to five years for bank CEOs with clear accountability for its functioning in critical areas like profitability and NPAs. If they fail in the task then  they should not be considered for any assignment post-retirement. The incentive scheme applicable to chairmen and managing directors and executive directors of PSBs should also be broadened and there should be negative marks for failure to achieve pre-set goals. Only this will ensure better performance.
Rot at the Top

One obvious reason for bank bad loans: controversial appointments, says Sucheta Dalal

If public sector banks (PSBs) are in trouble again, despite frequent recapitalisation by the government at the taxpayers’ expense, it is due to two major factors—rising NPAs caused by behest lending, and dubious loans (which are not meant to be repaid) sanctioned by senior bankers as the price of chairmanship. Corporate debt restructuring (CDR) was supposed to be a one-time affair and, along with the SARFAESI Act to help recovery of loans, it was supposed to be the end of excessive NPAs. Instead, banks have found a way around it all. CDRs are frequent and neither the regulator nor the government seems inclined to question them.

The main article has already pointed out how banks have blamed the rise in NPAs on the automated tracking system through core banking solutions (CBS). Now, RBI deputy governor, KC Chakrabarty has lashed out at banks for this. Bankers point out that repeated restructuring of loans is followed by deliberate devious acts such as feeding wrong data into the CBS system to hide stressed loan accounts. Friendly auditors also help camouflage bad loans and, when things begin to get really sticky, banks simply off-load the bad loan to an asset reconstruction company at a huge loss. This is the price for getting the loan off the bank’s books.

According to media reports, the real-estate sector is a big beneficiary of restructuring, accounting for about a tenth of the sticky loans. RBI officials admit that loans to loss-making state electricity boards ($5.5 billion outstanding) are a big problem, as is the huge bailout of Air India ($4 billion) in the public sector and Kingfisher (Rs7,500 crore after restructuring) in the private sector. There is also Paramount Airways, which cost New India chairman M Ramadoss his job, because he disguised a loan of several hundred crores of rupees as an insurance product (some say at the behest of a powerful minister and for the privilege of heading a larger insurance company). Corporation Bank chairman, Ramnath Pradeep, is another one who quit after an indictment by the Central Vigilance Commission.

A Reuters report in June 2012 quotes State Bank of India’s deputy managing director as saying that 43% of loans that the Bank restructured in March 2010 were declared non-performing within two years. The report also cites several cases of restructuring turned bad including Hotel Leelaventure, Electrotherm and some electricity companies. One of the most extraordinary cases was that of Central Bank of India which announced a net loss of Rs105 crore for the 31 March 2012 quarter, in its 101st year. Its bad loan provision has doubled, restructured loans trebled and slippages, despite restructuring, are a massive Rs3,300 crore in this quarter. Central Bank of India, which was headed by two controversial chairpersons, also had the ignominy of having MS Johar, an independent board director (a chartered accountant), being arrested by the Central Bureau of Investigation (CBI) in 2010 on charges of facilitating loans for a price. The arrest focused attention on several shady chartered accountants who are inexplicably appointed as directors on PSBs. A former bank chairman tells us that many of them broker dubious loans for corporate houses in return for choice appointments for bankers. The arrest of Mr Johar in 2010 has apparently made no difference to the system. A blog named, which has put out a long list of potential candidates to head banks, says, “The million dollar question is whether the lobby of corrupt bankers will be able to continue to dominate the scene and will have its own way” or will the prime minister “be able to exclude” some of the known corrupt names.

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