- Reason behind the NPA crisis
- Increase in credit
- Suggestions to counter future NPA crisis
- Suggestions for the government:
- Suggestions for banks:
Some key lessons from the NPA crisis
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Despite the introduction of prudential norms and a stringent regulatory mechanism, the Indian banking system is under strain. As of March 2018, non-performing loans at commercial banks peaked at ₹10.3 trillion or 11.2 % of total advances. The corresponding figures for public sector banks are ₹8.9 trillion and 14.6 %.
Reason behind the NPA crisis
Increase in credit
- Between 2003-04 and 2007-08, the outstanding non-food credit expanded by three times. It doubled till 2011-12 and increased 1.5 times in next four years.
- If bank finance for food related credit, it is called food credit under Agri Sector (i.e., crop loan). If bank finance for home loan to farmer, it is called (not related to food production) are Non-Food Credit under Agricultural loan.
- Moreover, assets under management of mutual funds and credit extended by NBFCs have also expanded enormously.
- However, there was considerable tightening of monetary policy between 2004 and 2008. Despite tightening and increase in repo rate and in cash reserve ratio (CRR), credit expansion happened extensively.
- Asset Quality Review (in which RBI conducted inspection of banks’ balance sheets in random) introduced in 2015 brought out greater transparency. It led to a doubling of the NPA ratio in one year. However, by that time, banks were left with a huge problem with no immediate relief.
Suggestions to counter future NPA crisis
Responsibility of Financial regulator:
The regulator has the responsibility to monitor macro-prudential indicators such as overall credit growth and also to spot excesses to certain sectors. This has implications when the RBI tightens or loosens monetary policy. The RBI’s concerns must be communicated to the government/owners, and made public.
Efficient resolution process
Despite several measures taken by the RBI, the performance of the resolution process has been slow and needs to be reviewed and remedial measures should be taken. The Insolvency and Bankruptcy Code (IBC) is an important in this context. However, loopholes need to be removed.
Suggestions for the government:
Improve relationship between government and boards/CEO
- The government can push the banks in certain directions. This may have immediate benefits but may cause problems in the medium term.
- The government should ensure that banks run in the larger national interest, but commercial decisions are best left to bank boards. Improvement in governance of the boards has been talked for long, but much needs to be done.
- The relationship between the government and the boards/CEO is still an unresolved question.
Specialised institutions for financing
- The government and regulators need to promote specialised institutions for project finance. The promotion of corporate debt markets, both for performing loans as well as distressed loans, needs special attention.
Empowered bank boards
- Banks boards must be empowered to decide on capital raising plans from the market within a well-defined framework.
- Recapitalisation may be done in cash rather than through bonds or in some combination.
Suggestions for banks:
Greater responsibility and training
- Banks need to take responsibility for the soundness of credit decisions. They need to define their own risk capacity.
- Also, banks need to significantly upgrade their project appraisal and monitoring skills and invest heavily in training.
Strengthened Assurance systems
- Assurance systems (internal and external audits and credit rating) need to be strengthened. Given the reported large scale siphoning of funds, round tripping of debt as equity through dozens of shell companies needs to be checked through forensic audits at annual reviews.
Ultimately the strength of the banking system depends on good judgment. Banking need not be either boring or adventurous. Similarly, bankers need not be either lazy or hasty. A proper balance needs to be struck.