Financial Stability Report and the issue of NPA

Structural reforms alone offer a viable long-term solution to the bad loans mess. Discuss in the light of recent developments related to the NPA situation in the Indian banking sector.

Recently, the Reserve Bank of India released the Financial Stability Report. The report presents a grim picture of bad loan problem faced by the Indian banking sector.

The main findings of the Financial Stability Report

The report essentially highlights the following.

  • India is still far away from solving the NPA problems of its banks.
  • The balance sheets of large business corporations are also not showing the signs of recovery.
  • The volume of the bad loans is increasing, despite the best efforts of the government.The gross non-performing assets (NPAs) in the banking system as a whole has risen to to 10.2% at the end of September 2017, from 9.6% at the end of March 2017.
  • According to a research report released by CARE Ratings, India stands fifth among significant economies with the most NPAs.
  • The RBI expects NPAs to continue to rise to as high as 11.1% of total outstanding loans by September 2018.
  • The bad loans problem has been getting worse for the private sector banks. The private sector banks have seen their asset quality deteriorate at a faster pace than public sector banks.
  • Private bank NPAs increased by almost 41%, as compared to 17% in the case of public sector banks at the end of September 2017.
  • Non-banking financial companies also saw a jump in NPAs.
The way forward
  1. It is clear that the reforms undertaken until now though have not been good enough to tackle the problem of NPA.
    In the months ahead several steps will have to be taken.
  2. The resolution of bankruptcy cases, particularly against large borrowers that contribute a major share of bank NPAs, under the new Insolvency and Bankruptcy Code must be undertaken aggressively. That should help bring the NPA situation under some control.
    The Code can be helpful in cleaning up bank books in future credit cycles.
  3. The recapitalisation of public sector banks too can help increase the capital cushion of banks and induce them to lend more and boost economic activity.
  4. One needs to be clear that bad debt resolution and recapitalisation are only part of the solution as they, by themselves, can do very little to control reckless lending that has pushed the Indian banking system to its current sorry state.
  5. India needs systemic reforms that address the problem of unsustainable lending. Only then, future credit cycles will not stress the banking system.
  6. The government should consider the recent advice of the International Monetary Fund to reduce its ownership stake in banks and give greater powers to the RBI to regulate public sector banks efficiently. Structural reforms are the only long-term solution.
  7. Even after having a ‘vigilance mechanism’ in vogue in the banking system, there are incidences of fraud relating to non-performing assets. Thus, merely issuing of guidelines or advisories by the government or the RBI for averting the incidences of fraud relating to NPAs do not seem to have yielded the desired results and the RBI — being a Regulator — does not seem to have succeeded. The government needs to impress upon the Reserve Bank of India to monitor and follow up strict compliance of relevant instructions with banks and financial institutions on a regular basis.
  8. The the existing vigilance mechanism need be revisited and, if required, be amended, to provide more teeth to it.
  9. Recently a Parliamentary panel asked the government to take urgent remedial measures to reduce the volume of stressed assets in the system and strengthen its vigilance mechanism. The government needs to follow up on that.