With the sharp spike in loan write-offs and non-performing assets and a steep fall in profits spooking the banking sector, Reserve Bank Governor Raghuram Rajan made it clear Thursday that banks “may require deep surgery” to clean up their balance sheets and put stressed projects back on track.
The classification of loans as non-performing assets (NPAs), he said, is an anaesthetic that allows the bank to perform extensive necessary surgery to set the project back on its feet.
“If the bank wants to pretend that everything is alright with the loan, it can only apply band-aids. For any more, drastic action would require NPA classification,” he said.
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Rajan’s observations came in the wake of reports about surging NPAs, loan write-offs and poor financial results by public sector banks. The Indian Express had reported that PSU banks had written off Rs 1.14 lakh crore in the last three years.
“But to do deep surgery such as restructuring or writing down loans, the bank has to recognise it has a problem, classify the asset as a non-performing asset,” Rajan said at a CII banking conference.
On the other hand, blaming the managements of public sector banks and borrowers for the asset quality mess, Reserve Bank Deputy Governor S S Mundra said the bad loan issue is largely due to governance issues at PSU banks as well as borrowers.
“One thing has come out quite clearly, that the issues we are seeing today have not much to do with the ownership of the banks. It is more a governance issue than an ownership issue,” Mundra said.
While there are external factors which have affected asset quality, internal ones are also as important and “governance deficit” is a big issue, he said, adding bank boards need to put in place risk management practices as per their appetite. The government owns majority stake in PSU banks.
“The present ailment is well within cure and that cure is being administered. For this, the willingness of the affected person is as important as medicine. I am happy to see that such will power is being shown (by banks),” Mundra said on the RBI directive to banks to notify certain loans as non-performing assets.
Referring to the impact of the clean-up exercise, Rajan said, “The market turmoil will pass. The clean-up will get done, and Indian banks will be restored to health. While we should not underplay the dimensions of the task, we should be confident that it is manageable and that the Government and the RBI will do what it takes to make sure that banks are able to support the tremendous growth that lies ahead.”
According to Rajan, for the loans that are of concern, the banks are attempting to regularise the loans that can be put back on track, and are classifying those that cannot for deeper surgery — and taking provisions in accordance with the degree of extant stress in the loan.
“They will also make provisions for loans that have weaknesses. Our intent is to have clean and fully provisioned bank balance sheets by March 2017,” he said.
“Why not do everything in one go rather than over a period of six quarters? Precisely because a number of these loans can be regularised, or stabilised when weak but regular, through the right collective actions,” he said. Sometimes, an NPA classification, even while permitting deeper surgery, prompts risk aversion on the part of bank boards and they stop lending even when the project is viable.
“We need to overcome this view — we have issued circulars stating that a loan to a project whose other loans are NPA does not automatically become an NPA — but it will take time. Pending the change in attitude, which I think will come as banks turn to unlocking the value in NPAs, we are working with them to sequence the most obvious actions up front. However, the end game is clear to everyone and bounded. We do not envisage a sequence of asset quality reviews,” he said.
Referring to the hit on bank profits, Rajan said: “While the profitability of some banks may be impaired in the short run, the system, once cleaned, will be able to support economic growth in a sustainable and profitable way. The economic assets of our public sector banks, such as the trust they are held in by the population, their knowledgeable employees, their location and reach, and the low-cost funding they have access to, can then be fully realised.”
Loan classification is merely good accounting — it reflects what the true value of the loan might be. It is accompanied by provisioning, which ensures the bank sets aside a buffer to absorb likely losses. “If the losses do not materialise, the bank can write back provisioning to profits. If the losses do materialise, the bank does not have to suddenly declare a big loss, it can set the losses against the prudential provisions it has made,” he said. The bank balance sheet then represents a true and fair picture of the bank’s health, as a bank balance sheet is meant to. “Of course, we can postpone the day of reckoning with regulatory forbearance. But unless conditions in the industry improve suddenly and dramatically, the bank balance sheets present a distorted picture of health, and the eventual hole becomes bigger,” Rajan said.