Asset quality of Indian banks improves to decadal high: RBI

Background: As per the Financial Stability Report by the Reserve Bank of India (RBI), the Gross Non-Performing Assets (GNPA) ratio reached 5% in September 2022. Concurrently, the ratio of Net Non-Performing Assets (NPAs) to net advances has decreased to 1.3% in September 2022, marking the lowest point in the last decade.

The NPAs had experienced an increase from 3.8% in 2014 to 11.4% in 2018. However, a subsequent decline in NPAs has been observed, attributed to reduced slippages, increased write-offs, and a rise in credit growth.

News:

Status of NPAs

Commercial Banks:

• In 2022-23, the combined balance sheets of commercial banks grew in double digits due to sustained credit growth.
• Higher lending rates and lower provisioning requirements boosted bank profitability and strengthened capital positions.
• The capital to risk-weighted assets ratio (CRAR) of scheduled commercial banks (SCBs) was 16.8% at end-September 2023, meeting regulatory requirements.

Urban Co-operative Banks (UCBs):

• The combined balance sheet of UCBs expanded by 2.3% in 2022-23, driven by loans and advances.
• UCBs witnessed improved capital buffers and profitability during 2022-23 and Q1:2023-24.

Non-Banking Financial Companies (NBFCs):

• The consolidated balance sheet of NBFCs expanded by 14.8% in 2022-23, led by double-digit credit growth.
• Profitability and asset quality of the NBFC sector improved in 2022-23 and H1:2023-24, with CRAR higher than regulatory requirements.

Unsecured Retail Segment:

• The unsecured retail segment's growth rate outpaced total bank credit growth in the recent period.
• The asset quality of unsecured retail loans has not deteriorated.

Non-Performing Assets (NPAs)

Non-Performing Assets (NPAs) refer to loans or advances where the borrower has failed to make the principal or interest payment for a duration exceeding 90 days.

Classification of NPAs by Banks:

Banks are obligated to categorize NPAs into Substandard, Doubtful, and Loss assets based on specific criteria.

• Substandard Assets: Assets classified as substandard if they have remained as NPAs for a period up to 12 months.
• Doubtful Assets: An asset transitions to the doubtful category if it has been classified as substandard for a continuous period of 12 months.
• Loss Assets: As per the Reserve Bank of India (RBI), a loss asset is deemed uncollectible, possessing minimal value to warrant its continuation as a bankable asset. Despite potential salvage or recovery value, its status as a viable asset is not justified.

Reasons for NPA Crisis in India:

• Global Financial Crisis: The 2008 financial crisis had a ripple effect on the Indian economy, leading to a slowdown in growth and increased NPAs in sectors exposed to the global market.
• Twin Balance Sheet Problems: Both banks and corporations faced financial stress due to the economic slowdown, leading to higher NPAs.
• Forbearance Policies: Banks often postponed recognizing NPAs by restructuring loans, masking the true extent of the problem.
• Stalled Judicial & Legislative Procedures: Delays in legal proceedings and land acquisition stalled infrastructure projects, leading to loan defaults.
• Other Factors: Aggressive lending, loan frauds, and poor recovery mechanisms also contributed to the NPA crisis.

RBI Measures:

Prompt Corrective Action (PCA) Framework (2002):

• Initiated by RBI to address NPA issues.
• Reviewed in 2017 based on recommendations of the Financial Stability and Development Council's working group.

Schemes for Debt Restructuring:

• Introduction of schemes like Scheme for Sustainable Structuring of Stressed Assets (S4A).
• Asset Quality Review to assess and address stressed assets. Circular of February 12, 2018:
• Granted banks the power to initiate insolvency proceedings.
• Set a timeline of 180 days for resolution plans.

Government's 4R's Strategy:

• Recognition:

Transparent recognition of NPAs.

• Resolution and Recovery: Comprehensive strategy for the resolution and recovery of value from stressed accounts.
• Recapitalization of PSBs: Infusion of capital in Public Sector Banks (PSBs) through the Indradhanush plan. Aimed at meeting regulatory capital norms and supporting growth capital.

Reforms in PSBs and Financial Ecosystem:

Implementing reforms in PSBs and the broader financial ecosystem. Aimed at fostering a responsible and clean system.

National Asset Reconstruction Company (NARCL):

• Introduced in the Union Budget for 2021-2022.
• Aims to resolve stressed loans totaling around INR 2 lakh crore in phases.

Indradhanush Plan:

• Focuses on capital infusion in PSBs by the government.
• Capital injection based on performance and potential to support growth.

Insolvency and Bankruptcy Code, 2016:

• A legal framework for addressing financial failures and insolvency.
• Provides an efficient mechanism for the resolution of insolvency for individuals and companies.

Tackling the NPA Crisis: Key Strategies for India

India's NPA crisis, with bad loans choking the banking system, demands immediate and effective action. Here are five crucial steps that can be taken:

1. Policy Alignment: Recognize the ripple effect: Government decisions outside banking can impact specific sectors. For example, mandatory renewable energy purchase obligations (RPOs) for state power utilities affect non-renewable project performance and contribute to NPAs.

Proactive evaluation: Implement time-bound assessments to evaluate project viability before financial commitments. This can shield banks from unintended NPA consequences of policy decisions.

2. Expedited NPA Resolution: Fast-track the Insolvency and Bankruptcy Code (IBC): The 2016 IBC law provides a framework for swift NPA resolution, but delays in adhering to its timelines hinder effectiveness. Streamlining judicial processes and ensuring timely completion of bankruptcy proceedings are crucial.

3. Bank Governance Revamp: Implement Nayak Committee recommendations: The committee proposed reforms to improve bank board governance, including greater professionalism and expertise. These recommendations should be adopted to strengthen decision-making and risk management within banks.

4. Institutional Restructuring: Strengthen the Banks Board Bureau: This government body plays a role in appointing bank chiefs, but further reforms are needed. Consider options like establishing a state-owned Bank Investment Company or fully handing over bank chairperson selection to the Bureau.

5. Deeper Reforms: Move beyond piecemeal solutions: While initiatives like the Banks Board Bureau are positive, more comprehensive reforms are necessary. Address structural issues within public sector banks (PSBs) and consider bold steps like privatization or consolidation.