Though banks have shown improvement in asset quality over the years, fast changing macro-economic scenario has thrown up renewed risks of accounts going bad in certain vulnerable sectors like telecom, airlines, small and medium enterprises, and agriculture.
A detailed study by The Associated Chambers of Commerce and Industry of India (ASSOCHAM) says there still remains a considerable scope for improvement in asset quality of Indian banking institutions and regulatory norms associated with them.
Gross non-performing assets (NPAs) of all scheduled commercial banks now comprise two per cent of advances compared to 15 per cent in late 1990s. In value terms, gross NPAs increased at a compound annual growth rate of less than one per cent since 2000-01 compared to 23 per cent growth in gross advances.
Similarly, gross NPAs of scheduled commercial banks – which were quite high to the extent of 8.1 per cent of net advances for the year ending March 1997 – declined to 6.2 per cent in March 2001 and further to just above a per cent towards March 2009 end.
Public sector banks led the improvement in NPAs, said the study conducted jointly by ASSOCHAM and investment bank Resurgent India. Investors are affected adversely if the proportion of toxic assets increases in overall asset portfolio of a company, it noted.
The study analysed this further and considered data for 11 listed banks for the year ending March 2010 which showed that proportion of NPAs to total loans stood at 2.21 per cent. If the ratio of NPA to total loans was a tad lesser at exactly two per cent, the market capitalisation would have increased by 6.4 per cent.
However, if the ratio is increased to 2.5 per cent, then market capitalisation would have reduced by nine per cent. With the same data set, the NPA level of 2.75 per cent – 54 basis points higher than the actual level – would have resulted in market capitalisation decreasing by 17 per cent.
Existence of high NPAs in one sector can lead to drying up of credit flow to others. This obviously leads to a contagion effect on the economy as a whole – especially if it is an important sector like housing, automobile, micro-finance and financial services, said the study.
The recent economic meltdown initially in the United States and then in rest of the world was a direct result of many loans going bad. Lax credit practices and availability of free credit empowered banks to lend credit to even sub-prime borrowers without sufficient checks.
On top of this, bundling these mortgage loans to housing sector in the form of mortgage backed securities and collateralised debt obligations led potential bad credit out of banks’ books and never reflected in the health of banking system. But the same existed in the system through harmful and complex derivatives created by banks and credit rating agencies.
As soon as these loans started going bad, banks and institutions holding these securities had to book significant mark-to-market losses which ultimately led to downfall of mighty institutions like Freddie Mae, Fannie Mac, Bear Sterns and Lehman Brothers. The world has still not been able to recover to pre-crisis levels.
The study thus recommended adequate insurance schemes for SMEs and agricultural sector (being the most vulnerable) to provide a meaningful cushion if the account turns bad. It is also imperative to favour public sector banks through taking over of bad loans from these accounts and compensating for restricted lending capacities.
Weather derivatives can be used for protecting crop loan portfolio. Corporate debt restructuring agencies can be established to encourage voluntary meetings between creditors and debtors, and to oversee an independent assessment of a company’s viability and worth.
Debtor assistance programmes can be devised to ease burden of falling employment, rising interest rates or devaluing currencies. Such programmes tend to be very popular politically and can be as necessary as bank assistance programmes. But they can raise moral hazard and undermine a payment culture if not managed properly.
Banks could be empowered to get a particular segment of clients’ business audited or verified by an independent entity to detect any possible warning signals. Also, increased participation from asset reconstruction companies is required to take toxic loans out of banks’ books. These companies need to be strengthened with capital infusion and efficient top management.
The government could carve out NPAs from banks being restructured, replace bad assets with government bonds on balance sheets and have NPAs managed by an asset management company to fix the problems.
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