Ominous signs of banking crisis

WITH a looming crisis in the Indian banking sector, caused by the sharp economic slowdown of the past few years and a rising portfolio of bad loans, the National Democratic Alliance government has decided to undertake some major reforms in the industry. Last weekend, Prime Minister Narendra Modi, along with finance minister Arun Jaitley and Reserve Bank of India Governor Raghuram Rajan, went into a huddle with heads of public sector banks (PSBs) and insurance companies in Pune at a ' gyan sangam' (a brainstorming session), aimed at rescuing the industry.

While India's banking sector appears to be stable and expanding at a healthy pace, there are ominous signs of a crisis in the industry, with a sharp deterioration in the quality of assets. Last week, the RBI, the central bank, in its Financial Stability Report, warned that 'the asset quality of scheduled commercial banks (SCBs) may worsen from the current level if the macroeconomic conditions deteriorate drastically and banks are likely to fall short in terms of having sufficient provisions to meet expected losses under adverse macroeconomic risk scenarios.'

The gross non-performing assets (GNPAs) of SCBs increased to 4.5pc of total advances in September, as against 4.1pc in March, while the net NPAs (NNPAs) went up to 2.5pc from 2.2pc during the same period. And if restructured assets are also taken into account, the stressed loans portfolio of SCBs goes up to 10.7pc of total loans (from 10pc in March).

Worse, in the case of PSBs, total stressed loans make up 12.9pc of their total loan books; for private sector banks, it is just 4.4pc. The total GNPAs of PSBs stood at Rs2.43trn towards the end of September. More than a third of these were on account of 30pc of NPAs.

Public sector banks have to raise that much money in capital by 2018 to meet the Basel III norms.

The government has a majority stake in 27 state-owned banks and will have to inject capital to help them meet the minimum norms. For this fiscal ending March 31, the government has allocated a mere Rs112bn for bank capitalisation. The NDA government now plans to reduce its holdings in PSBs to a maximum of 52pc, allowing these institutions to raise funds in the market. Many of the state-owned banks are already listed on the stock exchanges, but the amount of free floating stock is negligible.

"The extent of restructured assets in the banking sector, especially public sector banks, is a cause of serious concern," noted the central bank report. "There are 20 banks which have higher share in the total stressed advances of all SCBs than their share in the total advances of SCBs. These 20 banks together have 43pc of the total SCB loans and contribute around 60pc of the total stressed advances of the banking system."

The central bank also pointed out that stress tests indicate that the GNPAs of SCBs will fall to 4pc by March 2016 if the macro-economic scenario improves. "However, if macroeconomic conditions deteriorate, the GNPA ratio may increase further and under a severe stress scenario could rise to around 6.3pc by March 2016," it said.

The system level capital adequacy ratio of SCBs could decline to 9.8pc by March 2016 from 12.8pc in September 2014, under such a scenario. While the macro-economic vulnerabilities had reduced significantly on the back of an improvement in the growth outlook - especially the fall in inflation and because of political stability - the RBI cautioned domestic lenders to be alert to a reversal of portfolio inflows into India.

ON the eve of the crucial meet in Pune, the government unveiled the first few reforms measures to improve the functioning of state-owned banks. The finance ministry announced the names of new managing directors and chief executive officers for four banks, but decided to create a separate nonexecutive chairman's position.

At present, most PSBs are headed by a chairman and managing director, with both roles (of the head of the board of directors, and the CEO) combined in one position. Most private sector lenders - and also private companies - have separated the two positions. Even internationally, the posts of chairman and managing director/CEO are separate to ensure that there is no clash of interests.

But in India, PSB heads are appointed by the government, which in the past preferred to have one person heading both positions. An expert committee had recommended the separation of the two posts.

The finance ministry last week said under the new system, the chairman will be a part-time board member, who will preside over board meetings and not be an executive chairman. This would be the case with all PSBs, except State Bank of India. The RBI, which has also backed such a move, had also urged the government to appoint MDs/CEOs with fixed tenures. The government has, however, not pushed ahead with this reform measure.

The government's next move would be to reduce its stake in PSBs to 52pc. Last month, the union cabinet approved plans to raise about Rs1.6trn from the sale of its stake in PSBs, bringing it down to 52pc. Bank unions and left parties are opposed to the divestment of government stake, but the NDA government is expected to push ahead with the step. The Congress, when it was in power, had also decided to reduce the government's stake in PSBs.

However, the biggest link that needs be to broken is the nexus between politically powerful business groups - often headed by politicians - and state-owned banks. Many of the NPAs of nationalised banks are because of the clout of the borrowers, who force state lenders to extend loans, often ignoring prudent norms.

Many of the infrastructure-related loans that banks are unable to recover were extended to these businessmencum-politicians, who wielded enormous clout and got bank heads to release the funds. In the past, the government also packed the board of directors with political nominees, especially persons who had absolutely no connections with - or knowledge about - the banking and financial sector.