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Indian Banks’ High NPAs and Abysmally Low Recovery: Revamp or Perish

PSB reform and concomitant credit discipline is necessary not only to catalyze economic growth, but also to broaden and deepen financial market.

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India’s financial system is predominantly bank-based in which banks play major role in mobilizing savings, financing projects and working capital, and render other services to the business. There exists empirical evidence that flow of credit to business aids economic growth. Hence banking sector capable of meeting the credit needs of business can aid economic growth.
Correspondingly, non-performing assets (NPAs) and weak credit recovery can undermine credit availability and impede economic growth. Study in November 2018 has established that in India, NPAs impact GDP adversely. Since FY-2016, Indian banks, particularly the public sector banks (PSBs) have clocked unprecedented NPAs, is necessary to evaluate efficacy of banks in managing NPAs and credit recovery, and take necessary corrective action for the sake of the country’s economy.

NPA levels in India

Indian Banks NPA levels experienced spurt from FY-2016 and reached a peak of 11.2% in FY-2018 before improving to 9.1% in FY-2019 (figure-1). PSBs’ NPAs levels exceeded combined NPA levels of private and foreign banks in India after FY-2015.

Deluge in NPAs from FY-2016 resulted from Asset Quality Revie (AQR) of banks’ loan portfolios imposed by RBI in April 2015 and showed that the banks were concealing NPAs earlier. Such concealment was possible due to various restructuring schemes introduced by RBI starting with Corporate Debt Restructuring (CDR) in August 2001 and ending in Scheme for Sustainable Structuring of Stressed Assets (S4A) in June 2016. Barring exceptions these schemes failed to revive distressed accounts and catalysed loan evergreening by the banks, also observed by RBI. Though these schemes were withdrawn by RBI in February 2018, remnants of these and other restructurings remain with significant levels of marginal standard loans as restructured advances (figure-2) large parts of which are likely to become NPAs. The saving grace is that the standard restructured advances have tapered off post AQR and IBC, but threaten to rear the head again with ill-conceived suspension of fresh CIRP under IBC for six months.

Are PSBs’ excessive NPA levels attributable to random systematic market risks or some assignable causes? Comparison with peers worldwide can lead us to the answer.

India’s NPA levels and recovery: Comparative Disadvantage
World Bank (WB) study shows India’s NPAs are significantly more than the peers barring highly distressed countries such as PIGS countries, etc. Extent of India’s adverse NPA scenario can be seen from comparison Asian peers, European-US peers, and others.

NPAs in India as per WB’s comparative data are at variance with the data in the RBI website. For example, according to RBI, the gross NPA stood at 11.1% of gross advances (11.6% excluding NPAs of foreign banks) for FY-2018. Even with India’s lower NPA figure of 9.5% in WB data for FY-2018 (figure-3), India is marginally better than Bangladesh, but substantially worse off compared to other peers in Asia including lowly Pakistan.

India’s NPA levels are over double of NPA levels of European peers and USA (figure-4). The same holds true vis-à-vis other peers in the world (figure-5).

From WB data, it can be inferred that the acceptable bank NPA level should be less than 4%. Significantly higher NPAs denote systemic inadequacies or other assignable causes. Indian PSBs’ high NPA levels relative to private banks domestically and international peers indicate the presence of assignable causes which will not disappear on their own.

Poor NPA Recovery
India’s precarious NPA levels can be assuaged if recovery from NPAs is high and speedy. Unfortunately, here also, Indian banks are the worst performers relative to other countries including South Asian region countries as shown in WB analysis (figure-6).

India’s low recovery from NPAs is also corroborated from RBI’s data (figure-7).

Difference between NPA recovery percentages between WB and RBI data is attributed to the fact that some more recovery is likely from the NPAs considered in RBI data. RBI website does not contain recovery figures for FY-2018 and FY-2019 which are likely to be higher due to recovery under Insolvency and Bankruptcy Code, 2016 (IBC).

PSBs v/s Private Banks

PSBs being major players in banking, they have higher NPAs. However, PSBs account for increasingly disproportionate levels of NPAs share in relation to gross advances compared to private banks. During the 6-year period from FY-2014 to FY-2019, PSBs’ share of gross NPAs exceeded 80% except in FY-2019 when it was 79.2% (figure-8). During the same period, PSB share in gross advances declined from a high of 75.9% in FY-2013 to a low of 62.0% in FY-2019 (figure-9).

Causes and Remedies
Erstwhile RBI governor Dr. Raghuram Rajan’s comments on PSB’s working captures causes for PSB crisis:

Far too many loans are done without adequate due diligence and without adequate follow up. Collateral when offered is not perfected, assets given under personal guarantees not tracked, and post loan monitoring of the account can be lax. The lessons of the recent past should be taken seriously, and management practices tightened.

This statement is validated by RBI data which shows that private sector share in PSBs’ NPAs has been high and grew steadily from 50.2% in FY-2010 to a peak of 77.6% in FY-2016 (figure-9) before reducing to 72%in FY-2017. RBI has not uploaded later year figures which are likely to have worsened due to provisioning from IBC.

Are high NPAs with very low recovery due lack of adequate due diligence and without adequate follow up as observed by Dr. Rajan? Or is it due to complete lack of due diligence and follow up? This can be ascertained by analyzing PSB’s accounts which exemplify how PSBs (and some private banks) handle large credit risks. For example, a company ABC Power Private Limited (name changed for confidentiality) was sanctioned debt of Rs. 5544 crore by banks (ten PSBs, three private banks including one large private bank, and LIC) for setting up a coal-based power plant estimated to cost Rs. 6,930 crore, with a capacity of 1320-MW in Orissa in the year 2010. The banks did not mitigate project risks. While the equity investment risk was deemed mitigated without any analysis, the crucial technical, contractual, and construction schedule was left to be handled by “lenders’ engineers”. The banks/LIC disbursed total debt of Rs. 6440 crore (including part overrun) without any follow up. When the company was subjected to corporate insolvency resolution process under IBC, the secured debt along with interest stood at Rs. 8,217 crore. The resolution applicant who submitted resolution plan offered to the secured lenders, just Rs. one crore in cash and 5% equity for the project with face value of Rs. 51 lakhs. The resolution applicant did not find project asset valuation figure of around Rs. 900 crore credible. Transaction audit conducted by the resolution professional revealed diversion of debt of about Rs. 3000 crore. This was not known to the banks showing lack of monitoring.

ABC Power is under liquidation. The incomplete project with rusted equipment is likely to fetch scrap value to the banks. It is not an outlier, and with about 95% of the accounts under IBC in liquidation notwithstanding high % in some accounts such as Essar Steel (PSBs’ recovery - 90.5%), Bhushan Steel (PSBs’ recovery - 63%), Binani Cement (PSBs’ recovery - 100%), the overall recovery is likely to regress towards the average recovery experienced so far. This situation cannot be allowed to continue further.

Employee moral hazard
Dr. Raghuram Rajan in his book titled I do what I do euphemistically describes the grand bargain between the government and PSBs in which the banks undertake “special services and risks” for the government and are compensated in part by the government standing behind PSBs. The result is that PSBs fund infrastructure and other projects in private sector with lack of risk mitigation. The resultant losses erode banks’ capital which are periodically recapitalized by the government. This bargain has induced employee moral hazard and disincentive to perform. For example, after Industrial Development Bank of India’s (IDBI Bank now) initial public offering in 1995, the government shareholding had come down to 72.7%. After merger of its subsidiary IDBI Bank in FY2004, the government’s shareholding dipped to 51.2%.  Over years, it has galloped to 98.11% (including LIC’s investment). This constitutes limitless tolerance of the government, which has been injecting equity in the banks without deliverables, and without holding anyone accountable for continued failure over years. Same holds true for other PSBs.

Need for urgent PSB reforms

India has suffered from surfeit of unmanageable PSBs due to employee moral hazard and talent deficit for too long. Mercifully with recent bank mergers, the number and sizes of banks has become conducive for management revamp.  

PSB reform and concomitant credit discipline is necessary not only to catalyze economic growth, but also to broaden and deepen financial market. It is hoped that the government will take the bull by horn and implement PSB reforms without further delay lest the employee moral hazard and corporate-PSB crony capitalism results in unmanageable PSB crisis.

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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Rajendra M. Ganatra

Dr. Rajendra Ganatra has over three decades of experience in financial services in financial institutions, corporate sector and as erstwhile MD & CEO of SIDBI's ARC. He is currently Insolvency Professional and visiting faculty for MBA.

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