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Bad Loans and NPAs- What’s the Solution?

Once the banking sector gains expertise in project evaluation and monitoring the risks of project NPAs will be mitigated, and the recovery process will also be strengthened.

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For several years bad loans and the rising NPA’s problem have been persisting and being endured by the Indian economy. The situation was much worse during the years 2006-2008 when the first UPA government was in power. A large number of bad loans cases came into light during that period when our economic growth was much stable and stronger. This was the time when previous infrastructure projects like power plants were fulfilled in the specified duration and the allocated budget. 

This was also the time when the banks were at their peak of making lowly decisions, based on any business’s past growth and performance they assumed the future would be brighter and thus were willing to accept higher leverage in projects as well as reduced promoter equity. During this phase of development, the banks participated in the most irrational exuberance. They offered loans based on reports by the promoter’s investment bank rather than carrying out their own inspections. 

How did India get stuck in the NPA crisis?

Raghuram Rajan, the ex RBI governor, known for not mincing his words, shed his opinion on the NPA crisis in a detailed 17 page written deposition in 2018 where he listed out several factors that were responsible for the crisis.

Besides the over-optimism shown by banks in businesses when the economy was much stronger, the failure of banks in realising that the demand projections showed by various projects were far-fetched especially when the domestic demand decelerated during the time of unprecedented slow growth before the global financial crisis shows how the banks neglected the alarms right insight.

The insufficient pace of the government in taking decisions in several cases such as the government taking a sluggish approach and stalling projects on suspect allocation of coal mines due to fear of investigation in Delhi both under UPA as well as NDA government is another crucial factor that led to the rising service debts as the project cost runs kept on expanding due to the stalled projects. 

He highlighted other three reasons namely the loss of promoter and banker interest, the overconfidence of the banks that led them to conduct little due diligence and instead of doing independent analysis they outsourced it increases the likelihood of undue influence thus, corruption becomes one significant factor. 

The last reason he brought out is the sheer negligence and the lack of responsibilities of the banking sector, especially when the frauds are on rising. Though different from normal NPAs, a fraud takes place when there is a patently illegal action taken by the borrower or the banker. The banking system is hesitant and slow in calling out a scam because they dread the harassment that will follow by the investigative agencies and not much progress in catching the defaulter once they call a transaction a fraud.  

Is there a way out?

As per our previous RBI governor, Mr Rajan steps should be taken to prevent recurrences, which involves improving the governance of public sector banks and spacing them apart from the government. A more professional board should be set up and entrusted with all decisions. The top management of the PSBs has a talent deficit with limited hiring of outside talent, which should be more welcomed. Though this change can give rise to internal disputes but putting lakhs of crores of national assets on stake to build someone’s career isn’t a fair deal. 

For the year 2018-19, Finance Minister, Nirmala Sitharaman informed that a decline in the NPAs had been observed through execution of the 4Rs strategy by the government. This comprehensive step aims to clean up the banking system by Recognising NPAs transparently, Resolving and Recovering value from stressed accounts, Recapitalising PSBs and by introducing Reforms in banks and financial ecosystem.

Some steps the government is already acting upon to expedite and enable resolution of NPAs of PSBs involve the Insolvency and Bankruptcy Code (IBC), Securitisation and Reconstruction of Financial Assets and Enforcement of Security Interest (SARFAESI) Act and stressed asset management verticals as mentioned by Ms Sitharaman.

Once the banking sector gains expertise in project evaluation and monitoring the risks of project NPAs will be mitigated, and the recovery process will also be strengthened.

Disclaimer: The views expressed in the article above are those of the authors' and do not necessarily represent or reflect the views of this publishing house. Unless otherwise noted, the author is writing in his/her personal capacity. They are not intended and should not be thought to represent official ideas, attitudes, or policies of any agency or institution.

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Rakesh Tulsiani

Rakesh Tulsiani is the COO at Digitalabs. He has worked across industries, including Banking, Automobile, E-commerce, Government, Hospitality, Retail, Telecommunication, Health Care, Electronics, Insurance, Media, FMCG, and Education.

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