SLUMP IN NON-PERFORMING ASSETS

 

The gross non-performing assets (GNPA) ratio is the proportion of gross non-performing assets in gross loans and advances. 

The GNPAs are bad loans which the borrower is not in a position to repay at the moment. 

A loan turns bad or becomes an NPA if they are overdue for over 90 days. Banks have to set aside (or provision) a part of their profit as a buffer for potential losses that may arise from the NPAs. Thus, NPAs reduce a bank’s available capital to lend fresh loans. News reports say that the quarterly profits of commercial sector banks have touched an all-time high of around Rs.59,000 crore in September 2022. 

This is more than 50% higher than the profits recorded in the same quarter last year. The finance minister attributed the increase in bank profitability to the sharp reduction in non-performing assets

The gross NPAs of the commercial banks have rapidly declined from the peak levels of Rs.10,36,187 crore, which was about 11.2% of their gross assets, in March 2018 to Rs.75,37,835 crore or 5.9% of their gross assets by end March 2022, which is a six-year low.

Financial Stability Report of June 2022 estimates that the gross NPAs will further go down to 5.3% by March 2023 in a baseline scenario. However, the NPAs still remain at double-digit levels in a few sectors like mining and quarrying, food processing, engineering, gems and jewelry and construction.

The reduction of NPAs, comes at a very high cost. Numbers released by the government show that this sharp reduction in NPAs was mainly achieved through a write-off of loans amounting to Rs. 9.91 lakh crore in the five years ending 2021–22.

However, despite these huge write-offs, the recovery on the non-performing loans was only Rs.1.32 lakh crore, which is only 13.3% of the loans written off. 

 Banks voluntarily choose to write off NPAs to maintain healthy balance sheets.

 In the first half of FY23, the loan write-offs as a ratio of GNPAs slightly increased to 22.6% after declining for two consecutive years.

In December 2022, Finance Minister told Parliament that banks had written off bad loans worth ₹10,09,511 crore during the last five financial years. Writing off a loan essentially means it will no longer be counted as an asset.

By writing off loans, a bank can reduce the level of non-performing assets (NPAs) on its books. An additional benefit is that the amount so written off reduces the bank’s tax liability.

The bank writes off a loan after the borrower has defaulted on the loan repayment and there is a very low chance of recovery. The lender then moves the defaulted loan, or NPA, out of the assets side and reports the amount as a loss.

After the write-off, banks are supposed to continue their efforts to recover the loan using various options. They have to make provisioning as well. 

However, the chances of recovery from written-off loans are very low 

Public sector banks reported the lion’s share of write-offs at Rs 734,738 crore accounting for 72.78 per cent of the exercise. The only solace is that there has been a marginal improvement of recovery rates with the ratio of recovery to write-offs steadily going up from 8% in 2017–18 to 21.3% in 2021–22.

The balance sheets of the public sector banks mirror these trends. The data, in fact, shows that while the public sector banks wrote off Rs. 7.27 lakh crore in the five years ending 2021–22, they were only able to recover `0.96 lakh crore (13.2%) during this period.

One important factor that led to the reduction of the NPAs is the drop in slippage ratio of SCBs.

Slippage ratio is arrived at by dividing fresh NPAs by standard advances at the beginning of the period. The slippage ratio is around 2% in September 2022 for SCBs, which is the lowest since at least 2015. The poor recovery of loans by the banks is surprising; surprising because the banks have many recovery mechanisms to collect their dues. 

They can either file suits in debt recovery tribunals or civil courts under the Securitization and Reconstruction of Financial Assets and Enforcement of Security Interest Act, 2002 or recover loans by filing cases under the Insolvency and Bankruptcy Code in the National Company Law Tribunal.

The Reserve Bank of India guidelines allow banks to write off all NPAs, for which provisions have been made. 

While they have used the legal provisions to write off the loans and reduce their NPAs, and thus clean up their balance sheets, they still lag far behind in ensuring the recovery of the loans as the numbers suggest. This is very problematic as it creates a moral hazard. This is because the bulk of the NPAs is caused by the large borrowers, especially those who have an exposure of `5 crore and above.

Most recent estimates show that while large borrowers accounted for close to half of the loans provided by scheduled commercial banks in March 2022, accounted for almost two-thirds of the gross NPAs.

In fact, the share of large borrowers in the gross NPAs of banks was as high as three-fourths in September 2020.

The low recovery is a serious issue in the Indian context as the relative size of the NPAs of the Indian banking sector is especially large. 

NPAs of the Indian banking sector are much larger than not only that of the advanced economies but also in comparison with their peers in the developing economies and neighbouring countries. NPAs in advanced economies like South Korea, Canada, and Switzerland averaged less than 1% of the total assets, while it hovered in the 1%–2% range in countries like Singapore, Australia, Norway, China, Saudi Arabia, Malaysia, United States, United Kingdom, and Germany. 

In India, the average NPA was 6.6% in the last decade, which was higher than that of Sri Lanka, Spain, and United Arab Emirates but lower than that of Nigeria, Bangladesh, Russian Federation, Tanzania, Pakistan, and Italy where it was in the 7%–12% range

One reason for this acceleration in the NPAs is the expansion of corporate lending by banks, including infrastructure lending, which was badly affected by the slowdown in growth in recent years.

 In 2016, 40% of all outstanding credit went to industries, whereas just 20% was given out as retail loans. However, by 2022, retail loans’ share surpassed industry credit. This was due to the very high share of bad loans in the industry sector till 2018

The NPA in the industry sector has been brought down since, by a combination of recovery mechanisms such as insolvency and bankruptcy code & also by issuing fewer fresh loans to the industries. On the other hand, bad loans are barely there in the retail sector. 

 Bank profitability is gauged by measuring a bank’s Return on Assets (RoA = net profit by average total assets). An RoA of >=1% is generally considered good.