Does The RBI Really Think Banks Are Cleaning Up Their Balance Sheets?

The fifth monetary policy statement for the current financial year (2015-2016) was released by the Reserve Bank of India (RBI) earlier this week. In this statement the RBI points out that since the beginning of this year, the repo rate has been cut by 125 basis points (one basis point is one hundredth of a percentage). Repo rate is the rate at which RBI lends to banks and acts as a sort of a benchmark to the interest rates that banks pay for their deposits and in turn charge on their loans.

When the RBI cuts the repo rate it is expected that the banks will follow suit. As banks cut interest rates, the expectation is people will borrow more. But that doesn’t seem to have happened. Bank lending growth has continued to be in single digits. While the RBI has cut the repo rate by 125 basis points, the bank have cut their interest rates by only 60 basis points, which is less than half of RBI’s cut.

One of the reasons for this is that the bad loans have been piling up at banks, especially public sector banks. This hasn’t allowed banks to cut interest rates at the same pace as the RBI has cut the repo rate. Higher interest rates are being used to generate income which can compensate for losses on account of bad loans.

The RBI in the monetary policy statement is hopeful that “the on-going clean-up of bank balance sheets will help create room for fresh lending.” What this means is that once banks are able to clean up their balance sheets i.e. bring down their bad loans, they will be able to lower their interest rates and in the process greater lending will happen.

But how likely is this? The RBI declares the sectoral deployment of credit data every month. In this it gives out details of how much money was lent by banks to different sectors of the economy. Between October 2014 and October 2015, the banks have lent around Rs 1,15,800 crore to industry. This is an increase of 4.6%. Between October 2013 and October 2014, the lending to industry has gone up by 7.8%.

So far so good. Within industry, banks have lent Rs 73,500 crore to the infrastructure sector. Within the infrastructure sector, banks have lent Rs 55,600 crore to the power sector. Lending to iron and steel increased by Rs 22,200 crore between October 2014 and October 2015.

Hence, lending to the power sector and iron and steel sector was at Rs 77,800 crore. Given this, nearly two-thirds of all industrial lending by banks during the last one year has been to power and iron and steel companies. If we consider the entire infrastructure sector along with the lending to the iron and steel companies, then banks have carried out 82.6% of their industrial lending over last one year to companies operating in these sectors.

And why is that a problem? The RBI Financial Stability Report, which is released twice a year, with the last edition being released in June earlier this year, points out: “Five sub-sectors, namely, mining, iron & steel, textiles, infrastructure and aviation, which together constituted 24.8 per cent of the total advances of scheduled commercial banks, had a much larger share of 51.1 per cent in the total stressed advances. Among these five sectors, infrastructure and iron & steel had a significant contribution in total stressed advances accounting for nearly 40 per cent of the total.”

The power sector is a part of the infrastructure sector and a big defaulter of bank loans. Power sector loans form a little over 8% of total banks loans. Nevertheless they form 16.1% of the stressed advances.

Stressed advances are essentially gross non-performing assets (or bad loans) of banks plus restructured loans divided by the total assets held by the Indian banking system. The borrower has either stopped to repay this loan or the loan has been restructured, where the borrower has been allowed easier terms to repay the loan by increasing the tenure of the loan or lowering the interest rate.

What does this tell us? Basically 40% of the stressed advances of banks come from companies operating in the infrastructure and the iron and steel sectors. Ironically, banks have carried out more than 80% of their industrial lending to companies operating in these sectors, in the last one year.

Hence, banks are lending money precisely in those sectors where they have been losing money. Why are they doing that? A possible explanation is that new loans are being given so that the older loans that are falling due can be repaid. The companies operating in these sectors do not have the money to repay the loans they had taken on. In the process, the problem of recognising bad loans can be controlled, and the banks can kick the can down the road.

As the Financial Stability Report points out: “The debt servicing ability of power generation companies [which are a part of the infrastructure sector] in the near-term may continue to remain weak given the high leverage and weak cash flows. Banks, therefore, need to exercise adequate caution while dealing with the sector and need to continue monitoring the developments very closely.” What explains banks giving out more loans precisely to these companies?

With regard to the iron and steel sector the report had said that “the sector holds very good long term prospects, though it is currently under stress, necessitating a close watch by lenders.”

In fact, despite giving out fresh loans to the troubled sectors, the bad loans of banks have been on their way up. A recent newsreport in the Mint pointed out that bad loans of banks had risen to Rs 2,85,000 crore as on September 30, 2015. This was 22.9% higher than the total bad loans of banks as on September 30, 2014.
A report in The Indian Express puts the bad loans of banks at Rs 3,36,685 crore as of September 30, 2015. This is a rise of 27% from last year.

The RBI governor Raghuram Rajan recently said: “I want to put something like March 2017 on the table as when we hope that a full clean-up will have been done.” Is he being a little too optimistic here? That only time will tell.

(Vivek Kaul is the author of the Easy Money trilogy. He can be reached at [email protected])

The column originally appeared on HuffPost India on Dec 3, 2015