How did bank NPA crisis occur? Ex-RBI governor Raghuram Rajan explains in 6 points

The former RBI governor Raghuram Rajan has stolen the limelight in India after he aired his critical views on bank NPA crisis. Rajan recently presented his report on the rising NPA situation in the banks in front of a committee which was headed by Murli Manohar Joshi. Rajan did not shy away from explaining why the bank situation has gotten worse currently, so much so, that it is haunting India’s real economic growth potential. In past two fiscals, each coming quarter, either they be state-owned or a private lenders, all have reported a rise in their gross NPA. Every time it looks like this rise in stressed assets has ended, they raise their head consistently again. 

Because of huge chunk of NPA, the banks are lacking funds, higher provisions, weak deposits and muted credit growth which in return has taken a toll on their financial performance. It would not be wrong to say, in recent times, credit growth has started to taper off. As things stand, NPA crisis is still far away from resolution. 

Ever since the RBI had spoken of asset quality recognition (AQR) in 2015, there was an increase in the pace of recognizing these blighted assets.  

In its financial stability report, RBI itself believes that stress in the banking sector continues as GNPA ratio rises.

RBI, now under leadership of governor Urjit Patel, stated that macro-stress tests indicate that under the baseline scenario of current macroeconomic outlook, SCBs' (scheduled commercial banks) GNPA ratio may rise from 11.6% in March 2018 to 12.2% by March 2019. 

Here’s six main pointers that Rajan says are the cause of NPA crisis. 

Rajan said, “I have not seen a study that has unearthed the precise weight of all the factors responsible, but here is a list of the main ones.”

Over-optimism

A larger number of bad loans originated in the period 2006-2008 when economic growth was strong, and previous infrastructure projects such as power plants had been completed on time and within budget. 

It is at such times that banks make mistakes. They extrapolate past growth and performance to the future. So they are willing to accept higher leverage in projects, and less promoter equity. 

Rajan says, “One promoter told me about how he was pursued then by banks waving checkbooks, asking him to name the amount he wanted.”

Indeed, sometimes banks signed up to lend based on project reports by the promoter’s investment bank, without doing their own due diligence. 

Slow Growth 

Unfortunately, growth does not always take place as expected. 

The years of strong global growth before the global financial crisis were followed by a slowdown, which extended even to India, Rajan says, this shows how much more integrated we had become with the world. 

Strong demand projections for various projects were shown to be increasingly unrealistic as domestic demand slowed down. 

Government Permissions and Foot-Dragging

A variety of governance problems such as the suspect allocation of coal mines coupled with the fear of investigation slowed down government decision making in Delhi, both in the UPA and the subsequent NDA governments. 

Project cost overruns escalated for stalled projects and they became increasingly unable to service debt. The continuing travails of the stranded power plants, even though India is short of power, suggests government decision making has not picked up sufficient pace to date.

Loss of Promoter and Banker Interest

Ideally, projects should be restructured at such times, with banks writing down bank debt that is uncollectable, and promoters bringing in more equity, under the threat that they would otherwise lose their project. Unfortunately, until the Bankruptcy Code was enacted, bankers had little ability to threaten promoters (see later), even incompetent or unscrupulous ones, with loss of their project

Writing down the debt was then simply a gift to promoters, and no banker wanted to take the risk of doing so and inviting the attention of the investigative agencies. 

In reality though, because the loan was actually non-performing, bank profitability was illusory, and the size of losses on its balance sheet were ballooning because no interest was actually coming in. 

Malfeasance

Clearly, bankers were overconfident and probably did too little due diligence for some of these loans. Many did no independent analysis, and placed excessive reliance on SBI Caps and IDBI to do  the necessary due diligence. Such outsourcing of analysis is a weakness in the system, and multiplies the possibilities for undue influence. 

Too many bankers put yet more money for additional “balancing” equipment, even though the initial project was heavily underwater, and the promoter’s intent suspect. 

Fraud

The size of frauds in the public sector banking system have been increasing, though still small relative to the overall volume of NPAs. Frauds are different from normal NPAs in that the loss is because of a patently illegal action, by either the borrower or the banker. 

The investigative agencies blame the banks for labeling frauds much after the fraud has actually taken place, the bankers are slow because they know that once they call a transaction a fraud, they will be subject to harassment by the investigative agencies, without substantial progress in catching the crooks. 

Hence, from the above it can be said, lack of responsibilities and utmost negligence has now become banking systems biggest mistakes of all time. Now the situation is such that, the NPAs of PSBs is above thrice that of the private banks as of June 2018. NPA ratio of PSBs stood at 14.62% while that of private banks stood at 4.50% at the end of Q1FY19.