Banking

Banks and Sustainability

The ongoing COVID-19 pandemic is causing unprecedented disruptions to economic activities across countries, and India is no exception. The pandemic has severely affected and continues to disrupt global value chains, production, trade, services, and MSMEs thereby affecting overall growth and welfare.

India, due to its stringent lockdown, lost much of its economic output, so much so that its economy had contracted by 23.4% in the first quarter and by 7.3% in the overall financial year 2020-21. With the economy crippled to such an extent, how has the financial sector in the third-largest economy still fared a question of deliberation?

In its lowest growth since 1965, the loan portfolio of the banking system this year grew by just 5.6 percent. Given the circumstances that had been thrust upon the economy, RBI had introduced a moratorium on repayment of loans and had allowed banks to restructure loans to ease debts. Is due to this reason; we saw sluggish growth in the loan portfolios of different banks. On top of it, the government had guaranteed an Rs. 3 trillion emergency credit line to the troubled sectors.

Despite the existing challenges, some banks did record growth in bank credit but however, but that was driven by personal loans and credit to agriculture and allied activities. The loans to the MSMEs segment too grew due to the government’s guaranteed schemes. Thus, the net profit of some listed Indian banks during the financial year 2021 has more than doubled, growing from Rs 41,038 crore to Rs 1.03 trillion. But is this a façade or has the Indian financial system actually, finally cracked the solution to its archaic detestable problem of the NPAs?

With soaring profits at the moment, many might presume that India has finally cracked a solution to its draconian problem, but is such a trend sustainable? In January, the RBI’s last Financial Stability Report (FSR) had estimated that banks’ gross NPAs may rise to a humungous 13.5 per cent by September 2021, from 7.5 per cent in September 2020, under the baseline scenario. Additionally, in a severe stress scenario, these can rise to 14.8 per cent. Thus, till March, the banks could hold on to such a façade but not all of them will be in a position to stomach the impact of the second wave of the pandemic.

To mitigate the effects of the second wave, a sound banking system is a sine qua non for maintaining financial stability, which can be achieved by lifting off the dead weight of non-performing assets from its balance sheets. While there is no universally acknowledged official ‘acceptable’ limit for NPAs, bad loans within 3% are considered manageable.

Merely aiming to reduce NPAs is no solution. Realizing that better NPA recognition has become the need of the hour, RBI has begun conducting asset quality reviews across banks to ensure that the problem is addressed well in time rather than stretched or swept under the carpet. However, the extent of bad loans is yet to surface. Loan moratoriums and rescheduling have kept NPAs at bay.

Many corporates have suffered severely, but nobody knows what exactly is happening. The real damage shall bring to the surface over the next few quarters, as vaccine campaigns have ramped up and with COVID (hopefully) gone away, corporates shall begin to disclose their annual results and banks compelled to label their problem loans as NPAs.

Besides RBIs vigilance, Indian Public Sector Banks have entered a full-fledged consolidation mode wherein 27-odd public sector banks (PSBs) amalgamated into 10 large banks. The anchor banks such as Union Bank of India, Punjab National Bank, Indian Bank and Canara Bank are in the process of the branch and people rationalization, technology integration and stressed loan strategy etc.

Although PSBs took the blame for poor corporate governance and leadership, the private sector’s weak links are also exposed with Chanda Kochhar and Rana Kapoor coming under the radar for corruption charges or violating the service rules. Similarly, the mounting NPAs in their balance sheets indicate bad lending practices.

Investor sentiments are at an all-time low and it is also becoming evident how difficult it is going to be for banks all over the world to maintain good assets and good earnings. Additionally, despite banks’ provisioning of bad debts recovery is a long road ahead. This delay can be expected due to logjams in courtrooms and Tribunals thereby leading to ineffective recovery legislation at the grassroots level.

Due to the shutdowns and income slowdown, many repayments of loans, especially in Europe, United States, may cease leaving the banks dry. However, banking institutions are under immense pressure to ensure a business-as-usual amidst the lockdown and health crises. What were earlier their assets now would become a big risk and therefore necessitating the need to go beyond traditional modes of business vigilance to rise from the ashes left behind by the pandemic.

Tags: sustainable banking, sustainability in banking sector, banks and sustainability, sustainability in banking industry, economic activities, economic output, financial sector

Bad Loans Insurmountable Burden

A sound banking system is a sine qua non for maintaining financial stability in any country, which can be achieved by lifting off the dead weight of non-performing assets from its balance sheets. However, it is common knowledge that Indian banks are saddled with bad debts thereby ranking them as one of the worst in the world. In fact, it wouldn’t be wrong to state that India is definitely the worst in the BRICS bloc when it comes to its NPA management program.

While there is no universally acknowledged official ‘acceptable’ limit for NPAs, bad loans within 3% are considered manageable. As aforementioned, compared with most BRICS members, India fares quite poorly compared to China, as its NPA stands at 1.75% while India’s NPA stands at a whopping 9.85%.

In the recent case of PMC Bank, the bank’s last available numbers for March 31, 2019, showed a large deposit base of Rs 11,600 crore, a Gross NPA ratio of 3.76%, and a net NPA ratio of 2.19%, which did not seem out of the ordinary. However, its capital adequacy ratio was higher than the regulatory requirement of 12% and its advances were growing in the double digits.

From a macro-economic standpoint, countries with high NPAs typically do not have high economic growth, investment, and savings in the economy. Additionally, if loan non-recovery balloons, the bank’s net interest margin (NIM), profitability, return on assets, dividend payout, etc. all get severely affected, which in many cases does not spell well for the Bank’s credibility. Moreover, credit inflow is also jeopardized as its very financial soundness comes under scrutiny.

Despite its conspicuous impact on the economy, NPAs have an insurmountable burden on the investment and savings of investors like you and me. A high NPA ratio usually suggests that a bank’s management and recovery programs are flawed and hence an individual’s money isn’t safe in its mighty, hollow vaults. This emphatically leads to a low rate of savings for the people. Thus, due to burgeoning bad loan books, investment in the economy usually plummets.

Depositing money in a bank with a recent history of stress, a dicey reputation for governance, known problems in the loan book, or a precarious GNPA and capital adequacy position exposes you to the risk of RBI directions, which can deprive you of access to your money for temporary periods.

What is the main thrust on which a sound financial institution is built? It certainly is on in its safe asset keeping credibility. However, with the mounting NPAs, investor trust and confidence have drastically eroded. This increase in the systemic level in India’s banking sector (and the debt market) is certainly causing increased stress, and investors may find their money wiped out for no fault of their own.

Talking about liability management, high NPAs frequently provide an impetus to the banks to lower their interest rates on deposits thereby lowering the rate at which your investment in Fixed Deposits grows. Thus, in order to maintain their NPAs, the interest rates on loans and advances rise. This invariably increases the cost of borrowing thereby discouraging people from taking out loans and thus reducing the flow of money in the market.

This way, investors are not only deprived of their expected returns but also find the value of their investments eroded. Thus, the high burgeoning NPA crisis of a country can rattle its financial banking system and it can certainly prove to be a hurdle to its growth.

With the RBI conducting asset quality reviews across banks, better NPA recognition has become the need of the hour to ensure that the problem is addressed well in time rather than stretched or swept under the carpet. The extent of bad loans is yet to surface. Loan moratoriums and rescheduling have kept NPAs at bay. Many corporates have suffered severely, but nobody knows what exactly is happening.

The real damage shall being to surface over the next few quarters, as vaccine campaigns have ramped up and with COVID (hopefully) gone away, corporates shall begin to disclose their annual results and banks compelled to label their problem loans as NPAs.

With the growth of loans in the economy, once the moratorium is lifted and repayments start coming to banks, NPAs would significantly rise. In this aspect, RBI has asked banks to do provisioning, buffers, and raise capital, in order to be a resilient organizations. Such a conservative approach coupled with a strong legal framework is likely to pass on the benefits to investors like you and me.

Tags: financial stability, bad debts, bad loan bank, bad loans, bad loan recovery, bad loan write off, banks write off bad loans

Rise Of Banks: NBFCs with Fintech Companies

Consolidation in the banking industry is inevitable. Leading up to 2020, radically transformed Bank models have emerged. A glimpse ahead shows an emphasis on innovative technologies to vastly facilitate banking – inclusive banking through new types of Bank models, non-traditional alliances to make banking affordable, and Fintech capabilities to make banking customer-centric.

Banking in the future will leverage the geographic reach and financial know-how of NBFCs by joining hands with Fintech companies disrupting services with AI, Blockchain, and cybersecurity tools.

The bad loan history of Indian banks goes long back. In a recent development, another bank will be rescued due to its bad management program, but interestingly, not by the government this time, but by the NBFC sector. In recent developments uncovered, BharatPe and Centrum would rescue the significantly distressed PMC bank.

As SFB would acquire assets and liabilities of PMC bank, both the promoters are now permitted to start a small finance bank (SFB) in an equal ownership joint venture. RBI’s in-principle approval is a validation of Centrum’s experience in financial services and BharatPe’s digital expertise essential for setting up a new age bank. If this succeeds, it will be the first SFB in 6 years.

The bank’s gross NPA of 3.76% and net NPA of 2.19% were discovered by 2019. The reason for default in payments and bankruptcy, yet again, remains the same: financial irregularities and misreporting of loans. History bears testimony to the fact that the majority of Indian banks have treaded on the road of bankruptcy with their ill-suited loans that are handed out without thorough inspection of the credibility of the borrower. 

In the case of PMC, the bank had erroneously handed out loans to bankrupt real estate developer HDIL. Despite restrictions on withdrawals of cash and investigation of accounting lapses, RBI’s recent approval demonstrates an open runway for growth for institutions that adhere to regulations and rise out of ashes like a phoenix.

However, like all the other times, this time RBI used its underperforming problem-solving mechanism to counter the problem and dissolved the board, and took the administration of the bank under its purview. The quantum of loans to a single borrower was against banking guidelines. 

Amidst all the other rhetoric, what will acquisition mean for different stakeholders? At the outset, the acquisition will revamp the structure. PMC bank would change from a cooperative bank to a small finance bank. Though, it is to be noted that the existing loan and deposit accounts of PMC shall continue as it is, additionally the existing staff and branches shall be retained. However, some existing assets, loans portfolio of around ₹1000 crore, of Centrum would be part of the proposed small finance bank.

Talking about the Shareholders and members of the PMC Bank, according to reports there are more than 50,000 members of PMC bank. Since this transition is part of a rescue operation by RBI and the bank has a significant negative net worth, post this transition, members are expected to lose their invested money. Having talked about shareholders, one cannot leave behind the depositors of the PMC Bank.

Given the present circumstances, the bigger and humungous amounts would get their principal amount back. However, it is to be noted that there might be some haircut in interest earned or some cap on withdrawal limits to defer complete withdrawal. Given the present credit crunch, the RBI shall truly work to safeguard the interest of depositors.

With NBFCs growing twice the speed of banks, RBI increased its vigilance over the NBFC segment in light of the IL&FS and DHFL fiasco. In times where NBFCs can become banks, thanks to Section 22(1) of the Banking Regulation Act, 1949, a prudential regulatory framework for NBFCs looking to transform into banks should be implemented. This would help mitigate the spill-over of systemic risks inflicting NBFCs from further rupturing the banking system.

Access to public deposits is a salivating factor for NBFCs hit by a liquidity crunch during the pandemic, however, serious fine-tuning and deliberation are required for the treatment of PMC’s depositors, mostly consisting of individuals, religious trusts, and institutions, in the absence of a final revival plan.

From a macro-economic standpoint, it goes without saying that NBFCs looking to convert into banks will be required to maintain a higher Cash Reserve Ratio and Statutory Liquidity Ratio pursuant to RBI’s conversion guidelines. Post conversion, NBFCs will also enjoy some decline in the benefits of regulating in an unregulated field with focused disclosures, however, from a shareholder’s perspective, higher transparency and accountability are likely to instill a sense of confidence in such new-age banks.

From a macro-economic standpoint, the share prices of such newly formed banks will bear the brunt of changes in banking regulations, RBI circulars, and underlying risks directly applicable to banks.

With NBFCs like Centrum looking to tie up Fintechs is aiming to tap a large consumer segment that doesn’t have access to credit or can’t access credit at a good interest rate. Given the boundary that banks operate within, Fintechs and the shadow financing institutions are filling the gap by innovating and using multiple data points to lend by exploiting the digital potential.

While some classes believe that Fintechs are parasites riding on the network of the banking system and gaining valuations, however it goes without saying that inter alia, RBI must ramp up its monitoring game as marriages of convenience between NBFCs and Fin-techs are expected to witness a notable rise.

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Indian authorities

The second wave of the COVID-19 pandemic ushered in an era of disintegrating companies, arduous acquisition battles, and heated arguments in courtrooms. While most companies struggled to stay afloat, those with deep pockets jumped onto the acquisition and organic growth bandwagon. A giant that swore by this mindset was the Piramal Group whose resolution plan for Rs 37,250 for debt-ridden Dewan Housing Finance Limited (DHFL) received a conditional nod from the Nation Company Law Tribunal (NCLT), which subsequently received pompous and overwhelming approval from 94% creditors.
Despite being one of India’s largest mortgage lenders, DHFL’s tainted history of unwise financial handlings led towards it being the first financial services company to be notified for insolvency resolution under Section 227 of the Insolvency and Bankruptcy Code, 2016 by the Reserve Bank of India. The case itself poses as an exception, as the corporate insolvency resolution process under the Insolvency and Bankruptcy Code by the Reserve Bank of India is not applicable to financial service providers or banks. Therefore, the government’s action for the insolvency proceedings of financial service providers to enable the insolvency process of DHFL, which had defaulted on payment obligations, comes across an exception to the Code.
The NPA crisis in India is an archaic evil eating into the mighty edifice of India’s banking sector. However, the government’s sheepishly reluctant attitude to deal with the burgeoning crisis is indeed one of the factors that have led to the digging of the grave of the mighty financial sector of India. Statistically, India’s bad debts amount to 11% of the total lending, whereas corporate bad debts constitute 56% of the total bad debts of nationalized banks.
With another financial unit succumbing to the NPA crisis owing to governance concerns and payment defaults, India’s financial monitoring framework is ripe for reform and to nurse its post-pandemic financial system to health. The official perspective seems to maintain that the government looked after the vulnerable small and midsize firms during the pandemic. This, according to the official authorities, has been done by guaranteeing fresh bank loans and mortgages under RBI. Consequently, this belligerent view has been supported by the low take-up rate for the RBI’s one-time restructuring offer. Given low consumer confidence and crippled economic growth due to partial lockdowns, the NPA crisis is doomed to materialize sooner or later. According to the authorities, the NPA crisis can be dealt with later but how exactly is the question? Given, the DHFL insolvency, the financial system is doomed to fail given its failure to combat the NPA crisis.
Papering over an economy-wide solvency problem by flooding the financial system with high liquidity is not only risky but also fatal for financial stability. It is to be noted, that the same strategy of incessant capitalization of the financial sector by the Indian authorities has time and again proved to be a concocted measure in vain, as NPAs of the financial sectors have never plummeted in recent history. Even if they have, it is due to the practice of writing off loans from the accounting books in order to clean the financial records of the organization. But it is also something that the monetary authorities want to continue indefinitely which does little to help the bankrupt organizations. Alternatives, however, in the case of India are scarce. This is due to the fact that India doesn’t have good tools to deal with insolvency. The 2016 bankruptcy law, had been reeling under the pressure even before the pandemic had struck. Liquidation, the outcome in most bankruptcy cases, has led to creditors recovering only 15%. This gross inefficiency can be scrutinized when compared with the global average of 80%.
Given all the detestable conditionalities against the government’s liquidity approach, the government extended the same regime to failing shadow banks. Dewan Housing Finance Corp., as aforementioned, is a mortgage lender whose controlling shareholders are currently in judicial custody on charges of accounting fraud and misappropriation of funds. Talking about the archaic process adopted by the Indian authorities to settle DHFL, has left the suitors groaning about how shabbily the process was being run. With how the acrimonious contest shaped up, it’s certain that when the buyers control the reins, it will have to go through a lengthy legal challenge and will turn out expensive for creditors.
Clearly, due to all the aforementioned reasons, the task at hand is much more than filling the hole left by the $2.5 billion alleged fraud by Dewan’s former owners. With the government’s pro spending budget and increase in expenditure due to the vaccination campaign, bankruptcy in the financial sector is likely to wreak havoc on monetary and political goals of the Indian authorities with the DHFL precedent.

Understanding Bad banks and  NPA Crisis

With the banking sector crippling in the wake of COVID-19 induced depressionary forces, plans to place toxic assets in one or more bad banks have gained steam in recent weeks. Fundamentally, a Bad Bank purchases distressed assets from banks to eliminate toxic assets in their balance sheets and restore liquidity in the market. On account of the pandemic, India’s NPA crisis is all set to be exacerbated, where millions might not be able to uphold their end of the bargain.

Taking into consideration, the need to restructure the financial sector in India, Budget 2021-22 announced that the Centre will set up an ARC, commonly referred to as a bad bank, to resolve the issue.

Make no mistake, the Insolvency and Bankruptcy Code (IBC) and Asset Reconstruction Company (ARC) are two differentiable concepts. IBC aims toward the resolution and reorganization of insolvent companies, whereas ARCs are set up for clearing up NPAs. Thus, ARCs primarily deal with recovery, while the IBC seeks a resolution. Thus, ARC serves as a damage control policy rather than a damage prevention mechanism.

Given India’s deteriorating financial health, a preventive mechanism is the need of the hour. Given, Vijay Mallya’s felony to 17 banks, owing them 90 billion, which had sent shock waves throughout the market, Indian authorities should be cracking down on “bad boy billionaires” in order to restore financial discipline in the economy. Consequently, a preventive mechanism presents itself as an unadorned opportunity to usher India out of its bad bank crisis.

Shell companies, which are emphatically used by the corporate leaders to garb their revenues and clandestine corporate affairs, need to be rooted out from their core. The inefficiency to track such shell companies is what renders the government’s pursuit to counter defaulting banks, useless. It is to be noted that operating a shell company in India is not illegal.

With the shell company as a front, all transactions are shown on paper as legitimate business transactions, thereby turning black money into white. In this process, the business person also avoids paying tax on the laundered money.

It might come as a shock to many, but India does not have a concrete definition of shell companies. Shell companies are not defined in any law or act. This emphatically shows India’s reluctant attitude towards reviving its economy’s financial health. 

Have all the countries not defined shell companies in any law or act? No, the US has defined shell companies under their Securities Act. The US Securities Act defines shell companies as – “Securities Act Rule 405 and Exchange Act Rule 12b-2 define a Shell Company as a company, other than an asset-backed issuer, with no or nominal operations; and either: >no or nominal assets>assets consisting of cash and cash equivalents; or >assets consisting of any amount of cash and cash equivalents and nominal other assets.”

How ARCs or Bad banks won’t solve India’s burgeoning NPA problem?

It is no news that one of the worst victims of the ongoing economic crisis in India is the country’s already wounded financial sector. As per various reports, with businesses struggling to survive, bad loans are expected to rise, denting Indian banks’ health. But as a law of nature, someone’s loss is another’s gain. Here the only organization smelling opportunity is ARCs.

As can be expected, given the current state of the Indian economy, ARCs demand in India going forward is all set to rise as the economic slump will eventually lead to a surge in non-performing assets (NPAs).

Even the global players are smelling an opportunity. Canada-based asset management firm Brookfield is reportedly going to set up an ARC in India. But does that imply that ARCs are devoid of problems? Certainly not. The economic crisis, which provides them with a huge opportunity, has also adversely impacted their business of raising capital to recover money.

As aforementioned, raising capital for acquiring more assets is one of the biggest challenges faced by ARCs. Initially, ARCs had a fee-based business model. Banks had to pay ARCs a fee to handle their bad loans, but with the introduction of the 5:95 rule by the Reserve Bank of India (RBI), the easy business became difficult.

Under the 5:95 rule, if ARC was buying a stressed asset, it had to invest a minimum of 5% of the acquisition price. Later, the woes of ARCs were exacerbated under Raghuram Rajan, when this ratio was increased to 15%. This certainly led to ARCs having more skin in the game.

Secondly, given the current economic slump, ARCs’ probability to recover bad loans has plummeted adversely as people are unable to pay back their liability. The ability to pay has also been adversely impacted by the operational difficulties that are being faced by the borrowers due to the lockdown.

Thus, more time is being asked to repay their dues. Additionally, some of the asset sales, which were in the process of getting completed, have been postponed due to the pandemic. Similarly, IBC cases have been delayed as the National Company Law Tribunals (NCLTs) are not fully functional. Thus, raising capital for acquiring more assets is one of the biggest drawbacks and challenges for bad loans.

As the financial crisis continues, the need to remove troubled assets from financial institutions’ balance sheets has become critical. Confidence in our banking and the financial system requires confidence in our financial institutions and the ongoing reporting of losses and write-downs continuously hampers progress.

Therefore, it is imperative to see the situation as-is wherein ARCs and Bad Banks may provide incremental improvements but is unlikely to dramatically restore balance sheets. Indian financial structure additionally needs the option of restructuring stressed assets and IBC and a preventive measure to treat the root cause of the problem, which is segregation of troubled assets and timely risk management.

Tags: bad loan bank, bad loans, Bad banks, npa crisis, banks for bad credit, about bad bank

Bank Nationalization

As the pandemic continues to ravage lives and livelihoods, one unintended victim shall be the Indian banking industry. In the newfangled language of the virus, those with co-morbidities will suffer. This includes financial institutions – banking and non-banking.

In the economic sense, public sector banks (PSBs) which entered the pandemic quite fragile are likely to be severely hit. The reason is, that the knock-on effects from worst-hit sectors during the pandemic will flow directly to banks and NBFCs further exacerbating the non-performing assets (NPAs) problem. Therefore, during such testing times, the Indian government has provided relief to stimulate the sluggish economy and prevent economic disasters.

In the past year, the Reserve Bank of India (RBI) had allowed moratoriums, which will pile up and create a negative impact over the course of this year and the next. Fortunately, RBI permitted a one-time restructuring of loans to companies in the distressed sectors to iron out this problem.

Furthermore, RBI can loosen its prudential norms to a pre-1992 era and not recognize bad loans – a move that is likely to allow banks to operate at a slower pace of credit in the economy, given government ownership prevents runs on banks. Alternatively, recapitalization of the banks by an extremely cash-strapped government can be considered by RBI. However, both options are tough and the gravity of the crisis cannot be washed away.

One result of a distressed economy and failing monetary reliefs indicates that the government may be required to play a significant role in the fate of many banks. When the government does intercede, the topic of nationalizing banks often arises soon after, and the subject stirs lively debates.

After having observed just over 50 years of the majority of the Indian Banks having been nationalized, a debate between the erstwhile stance and a recent privatization-led regime has arisen.

Whilst bank nationalization stood for energizing priority sectors, the crumbling and debilitated functionaries and MSMEs that were, and to a great extent, still are, in desperate need of well-regulated credit, the recent view on privatization of these banks has opted for a rather capitalism driven approach.

The emergence of the school of thought that re-privatization of PSBs finds its roots in the ideologies that are rooted in advocacy for freely flowing competition in the marketplace, where individuals fend for their own selves, where they adapt, survive and overcome, or succumb to marketplace fiends and secede to stronger competition.

To such a school of thought, governmental aid comes a as bail-out option, aimed at keeping the proverbial ‘ailing and wounded animal’ alive rather than putting it out of its misery.

However, amidst all the hue and cry between the two, the intent behind the Indira Gandhi government of 1964 should once again be taken into consideration, which so feebly hangs between the two. The concept of wiping out NPAs and Bad Assets from the economy not only warrants efficient working of recovery mechanism under the SARFAESI, I&B Code, and the RDDBFI but also deems the establishment of institutions such as Bad Banks as necessary.

In essence, the revitalization of the nationalization led movement would require the functioning of Bad Banks, wherein procurement of NPAs stressed assets and bad loans would further the intent behind the revitalization of the erstwhile intent, while also maintaining a quasi-capitalistic mechanism of banking institutions being run, that emulate the recent privatization led ideologies.

Furthermore, since the procurement of banks of illiquid assets with credit risks is done, the banks earn hefty incentives from the government in the form of credit-provisioning subsidies and liquidity-increasing tools. Thus a healthy synergy between the banks, the public they’re targeting and the government, to encourage such banks, may be seen as vital for a reinvigorated credit facilitation system and the Indian economy at large.

Tags: nationalization of commercial banks, all nationalised bank, nationalisation of commercial banks, non nationalised bank, bank nationalization, nationalized banks, nationalisation of rbi