Privatization by Malign Neglect: Nationalized Banks Gave Out Just 6% of Banking Loans in 2020-21

One story that I have closely tracked over the years is the privatization of the Indian banking sector, despite the government continuing to own a majority stake in public sector banks (PSBs). I recently wrote a piece in the Mint newspaper regarding the same.

The moral of the story is that the PSBs have continued to lose market share to the private banks, over the years. This is true of both deposits as well as loans.

In the last decade and a half, when it comes to loans, the share of PSBs in the overall lending carried out by scheduled commercial banks in India  peaked at 75.1% in March 2010. As of March 2021, it had fallen to 56.5%.

When it comes to deposits, during the same period, the share of PSBs in the total deposits raised by scheduled commercial banks peaked at 74.8% in March 2012. As of March 2021, it had fallen to 61.3%. Meanwhile, the private banks had gained share both in loans as well as deposits. (For complete details read the Mint story mentioned earlier).

One feedback on the Mint story was to check for how well PSBs other than the State Bank of India (SBI), the largest PSB and the largest bank in India, have been doing. In this piece, I attempt to do that. Data for this piece has been drawn from the Centre for Monitoring Indian Economy (CMIE) and several investor presentations of SBI. The data takes into account the merger of SBI with its five associate banks as of April 1, 2017.

Let’s take a look at the findings point wise.

1)  Let’s start with the share of different kinds of banks in the overall banking loan pie.

Source: Author calculations on data from the
Centre for Monitoring Indian Economy
and the investor presentations of SBI.

In the last 15 years, the share of SBI in the overall banking loan pie has been more or less constant (look at the blue curve, it seems as straight as a line). It was at 23.1% as of March 2006 and it stood at 22.7% as of March 2021. Clearly, SBI has managed to hold on to its market share in face of tough competition from private banks.

But the same cannot be said of the other PSBs, which are popularly referred to as nationalized banks, given that they were private banks earlier and were nationalized first in 1969 (14 banks) and later in 1980 (six banks).

The share of these banks in the lending pie has fallen from 47.9% in March 2006 to 33.8% in March 2021.

In fact, the fall started from March 2015 on, when the share of the nationalized banks in overall lending had stood at 50.1%. This is when the Reserve Bank of India (RBI) rightly started forcing these banks to recognise their bad loans as bad loans, something they had been avoiding doing since 2011, when the bad loans first started to accumulate. Bad loans are largely loans which haven’t been repaid for a period of 90 days or more.

Not surprisingly, the share of private banks in the banking loan pie has been going up. It is up from 20% to 35.5% in the last 15 years, though a bulk of the gain has come from March 2015 onwards, when the share was at 20.8%. Clearly, the private banks have gained market share at the cost of nationalized banks. As stated earlier, SBI has managed to maintain its market share.

2) Now let’s take a look at the deposit share of different kinds of banks.

Source: Author calculations on data from
the Centre for Monitoring Indian Economy
and the investor presentations of SBI.

The first thing that comes out clearly is that the shape of the curves in this chart are like the earlier chart, telling us that conclusions are likely to be similar.

When it comes to overall banking deposits, the share of SBI has been more or less constant over the last 15 years. It has moved up a little from 23.3% to 23.8%, with very little volatility in between.

For nationalized banks, it has fallen from 48.5% to 37.4%, with a bulk of the fall coming post March 2015, when it had stood at 51%.

The fall in market share of nationalized banks has been captured by private banks, with their share moving up from 19.4% to 29.9% in the last 15 years. Again, a bulk of this gain has come post March 2015, when their market share was at 19.7%. Clearly, as nationalized banks have been trying to put their house back in order, private banks have moved in for the kill and captured market share.

The two charts clearly tell us that the banking scenario in India has been changing post March 2015, but they don’t show us the gravity of the situation.

To do that we need to look at the incremental loans given out by the banks each year and the incremental deposits raised by them during the same year. Up until now we were looking at the overall loans given out by banks and the overall deposits raised by them, at any given point of time.  

3) Let’s take a look at the share that different kinds of banks have had in incremental loans given out every year. Incremental loans are obtained in the following way. The outstanding bank loans of SBI stood at Rs 25 lakh crore as of March 2021. They had stood at around Rs 23.7 lakh crore as of March 2020.

The incremental loans given between March 2020 and March 2021, stood at Rs 1.3 lakh crore. This is how the calculation is carried out for different banks across different years. The number is then divided by the incremental loans given out by scheduled commercial banks, and the market share of different kind of banks is obtained.

In 2020-21, the total incremental loans given by the banks stood at Rs 5.2 lakh crore. Of this, SBI had given out around Rs 1.3 lakh crore and hence, it had a market share of around one-fourth, when it came to incremental loans given by banks.

Source: Author calculations on data from the
Centre for Monitoring Indian Economy
and the investor presentations of SBI.

The above chart tells us is that post March 2015, a bulk of incremental lending has been carried out by private banks. In 2014-15, the private banks carried out by 35.6% of incremental lending. This touched a peak of 79.5% in 2015-16 and their share was at 58.9% in 2020-21, the last financial year.

SBI’s share in incremental lending hasn’t moved around much and it stood at 24.4% in 2020-21.

The real story lies with the nationalized banks. Their share of incremental lending has collapsed from a little over half of the incremental lending in 2013-14 to just 0.2% in 2019-20. In 2020-21, it was slightly better at 6.3%.

These banks have barely carried out any lending in the last five years, with their share being limited to 6.1% of the incremental loans that have been given during the period. SBI’s share stands at 25.3% and that of private banks at 59.9%.

4) Now let’s look at how the share of incremental deposits of different kinds of banks over the years.

Source: Author calculations on data from the
Centre for Monitoring Indian Economy
and the investor presentations of SBI.

This is perhaps the most noisy of all the charts up until now. But even here it is clear that the share of nationalized banks in incremental deposits has come down over the years. It was at 50.9% in 2013-14. In 2017-18, the deposits of nationalized banks saw a contraction of 8.5%, meaning that the total deposits they had went down between March 2017 and March 2018. In 2020-21, their share of incremental deposits stood at 26.3%.

The chart also tells us that in the last six years, the private banks have raised more deposits during each financial year, than SBI and nationalized banks have done on their own.

5) In the following chart, the incremental loan-deposit ratio of banks has been calculated. This is done by taking the incremental loans given by banks during a particular year and dividing it by the incremental deposits raised during the year.

Source: Author calculations on data from the
Centre for Monitoring Indian Economy
and the investor presentations of SBI.

The curve for non SBI PSBs is broken because in 2017-18,
the banks saw a deposit contraction,
and hence, the incremental loan deposit ratio
of that year cannot be calculated.

The incremental loan deposit ratio of nationalized banks collapsed to 0.5% in 2019-20 and 7.4% in 2020-21. What this means is that while these banks continue to raise deposits, they have barely given out any loans over the last two years. In 2019-20, for every Rs 100 rupees they raised as a deposit they gave out 50 paisa as a loan (Yes, you read that right!). In 2020-21, for every Rs 100, they raised as a deposit they gave out Rs 7.4 as a loan.

One reason for this lies in the fact that many of these banks were rightly placed under a prompt corrective action (PCA) framework post 2017 to allow them to handle their bad loan issues.

This placed limits on their ability to lend and borrow. Viral Acharya, who was a deputy governor of the RBI at that point of time, did some plain-speaking in a speech where he explained the true objective of the PCA framework:

“Such action should entail no further growth in deposit base and lending for the worst-capitalized banks. This will ensure a gradual “runoff” of such banks, and encourage deposit migration away from the weakest PSBs to healthier PSBs and private sector banks.”

The idea behind the PCA framework was to drive new business away from the weak banks, give them time to heal and recover, and at the same time ensure they don’t make newer mistakes and in the process minimize the further accumulation of bad loans. This came at the cost of the banks having to go slow on lending.

As I keep saying there is no free lunch in economics. All this happened because these banks did not recognise their bad loans as bad loans between 2011 and 2014, and only did so when they were forced by the RBI mid 2015 onwards.

There is a lesson that we need to learn here. The bad loans of banks will start accumulating again as the post covid stress will lead to and is leading to loan defaults. It is important that banks do not indulge in the same hanky-panky that they did post 2011 and recognise their bad loans as bad loans, as soon as possible.

What banks did between 2011 and 2014, when it comes to bad loans, has already cost the Indian banking sector a close to a decade. The same mistake shouldn’t be made all over again.

Now with many of the nationalized banks out of the PCA framework, their deposit franchises remain intact, nonetheless, they don’t seem to be in the mood to lend or prospective borrowers don’t seem to be in the mood to borrow from these banks, and perhaps find borrowing from private banks, easier and faster.

Of course, one needs to keep in mind the fact that 2020-21 was a pandemic year, and the overall lending remained subdued.

Meanwhile, the private banks keep gaining market share at the cost of the nationalized banks. This means that by the time the government gets around to privatizing some of these banks, if at all it does, their business models are likely to have completely broken down. They will have deposit bases without adequate lending activity. 

The nation shall witness what Ruchir Sharma of Morgan Stanley calls privatization by malign neglect, play out all over again, like it had in the airline sector and the telecom sector, before this.

 

On Homes and Home Loans

Yesterday evening I had gone to meet a cousin who lives in the Western suburbs of Mumbai. All along the way, there were billboards of Kotak Mahindra Bank advertising its home loans, which are available at an interest rate of 6.65%.

While the interest rate of 6.65% comes with terms and conditions, such low interest rates have rarely been seen before. It is possible to get a home loan these days at an interest rate of 7%.

A few things have happened because of these low rates. There have been scores of stories in the media citing surveys where everyone from women to HNIs to NRIs to millennials seem to want to buy a house and they want to do it right here and right now. 

Of course, these surveys have been carried out by real estate consultants, whose very survival depends on the real estate sector doing well. Incentives as they say.

Low interest rates on home loans also have led to stories in the media suggesting that this is best time to buy a house. The other thing that has happened is that analysts have been recommending stocks of home finance companies (HFCs).

The logic being that at lower interest rates people will take on more home loans. This will help the loan book of HFCs grow, making them good investment bets. How easy all this sounds? But is it?

All this stems from the flawed assumption that people borrow more at lower interest rates and live happily ever after. Let’s see if that is true or not.

Take a look at the following graph. It plots the increase in home loans outstanding during the period April to January, over the years.

 Source: Author calculations on data from Centre for Monitoring Indian Economy.

What does the above graph tell us? It tells us that despite very low home loan interest rates, the increase in home loans given by banks between April 2020 to January 2021, stood at Rs 78,577 crore. This was around half of the increase of Rs 1,56,362 crore between April 2019 to January 2020.

Even between April 2018 and January 2019, the increase stood at Rs 1,46,227 crore. Clearly, people borrowed much more when interest rates were higher. Hence, the logic that people borrow more when interest rates are lower, basically goes for a toss.

In fact, the increase between April 2020 to January 2021, was the second lowest in six years in absolute terms. The lowest increase of Rs 74,837 crore was between April 2016 to January 2017. This period included demonetisation when banks had more or less stopped doing everything else and concentrated on taking back the demonetised notes from the public.

If we look at the period between April 2016 to October 2016, before demonetisation happened, the increase in home loans had stood at Rs 64,501 crore. Clearly the disbursal of home loans slowed down in the post demonetisation months.

There is another point that needs to be made here. Other than banks, HFCs or home finance companies, also give out home loans. Typically, banks give out two-thirds of the home loans and HFCs, the remaining third. Nevertheless, the last couple of years haven’t been good for a few HFCs. This has meant that some of the business of home loans has moved from HFCs to banks.

Once we take these factors into account then we can conclude that the increase in home loans during this financial year, has been the worst in six years. And this despite the extremely low interest rates. In percentage terms, the increase in outstanding home loans during this financial year has stood at 5.97%, the lowest in six years, and the only time the increase has been less than 10%. 

Why is that the case? For economists and analysts, the interest rate is the most important parameter that people look at while taking a home loan, nevertheless, a little bit of common sense tells us that this isn’t the case.

Let’s try and understand this through an example. As per HDFC, India’s largest HFC, their average home loan size is Rs 28.5 lakh. Their average loan to value ratio at the time of giving the loan is 70%. This basically means that HDFC on an average gives up to 70% of the price of the home as a home loan.

This basically means that the average price of a home in the books of HDFC against which they give a home loan, stands at Rs 40.7 lakh (Rs 28.5 lakh divided by 70%). Let’s round this to Rs 41 lakh, for the sake of convenience.

What does this mean? It means that in order to buy a home, other than taking on a loan of the buyer first needs to make sure that he has savings of around Rs 12.5 lakh (Rs 41 lakh minus Rs 28.5 lakh) to make the downpayment on the home loan. Even if the money is available, he or she needs to make sure that they are in a position to spend that money.

This is not where it ends. In many parts of the country a portion of the real estate transaction is still carried out in black. Money needs to be available for that. Further, a stamp duty needs to be paid to the state government. Then there is the cost of moving into a new house (everything from transport to perhaps new furniture).

Once we factor these things into account, we can conclude that the home loan forms around 50-60% of the overall cost of buying a house. Further, in a time like present, any individual thinking of buying a house will have to weigh the decision against the possibility of losing their job or facing a drop in income in their line of work.

Now let’s consider the average home loan of Rs 28.5 lakh. At 7% interest and a tenure of 20 years, the EMI on this amounts to Rs 22,096. At 9%, the EMI would have worked out to Rs 25,642. Hence, the EMI is Rs 3,546 lower.

So, yes, the EMI is lower. But what will the buyer first look at? The lower EMI or the ability to be able to pay the lower EMI and be able to continue paying it in the days to come. Of course, the buyer will look at his ability to pay the EMI and be able to continue paying it. Also, it needs to be remembered that the interest rate on the home loan is a floating one, and can rise in the years to come.

Hence, this decision will be based on the confidence that the buyer has in his or her own economic future. This is not something that can be measured at an aggregate system level and varies from buyer to buyer. The point being that everything that is important cannot necessarily be measured in numerical terms.

Having said that, the confidence in the economic future will be currently low, with many individuals losing their jobs or seeing their friends, relatives and acquaintances lose jobs. Hence, other than losing a job, there is also the fear of losing the job. There has also been a drop in their income or in some cases small businesses have been shutdown. 

Also, whether it is the best time to buy a house or not, like most things in personal finance, it depends on your finances and more importantly your mental makeup of what you want from life. If you want to settle in life and make your parents and relatives happy, and have the money to do so, then now is as good a time as any to buy a home.

Please keep this in mind at every point of time in life when some expert tells you that this is the best time to do this or the best time to do that.

So, right now if you think you have enough money and enough confidence to keep paying the EMI, and want a home to live in, then please go ahead and buy one. Also, make sure that you have enough savings to pay the EMI for at least six months to a year, even without your main source of income.

To conclude, buying a home is not just about low interest rates. There are several other factors, which people who are in the business of selling real estate, seem to conveniently forget about.

Then there are surveys in which a high proportion of people end up saying they want to buy a home to live in. Of course, they do. But just wanting to do something doesn’t add to demand. I mean, I want to buy a house in central Mumbai, but I also know that ain’t going to happen. My finances don’t allow it.

How Trustworthy are the Bad Loans Numbers of Banks?

The Reserve Bank of India (RBI) in the Financial Stability Report (FSR) released in January had said that by September, the bad loans of banks, under a baseline scenario, could shoot up to 13.5% of their total loans. In September 2020, the bad loans rate of banks had stood at 7.5%. Bad loans are largely loans, which haven’t been repaid for a period of 90 days or more.

If the economic scenario were to worsen into a severe stress scenario, the bad loans could shoot up to 14.8% of the loans. For public sector banks, the rate could go up to 16.2% under a baseline scenario and 17.8% in a severe stress one.

What this meant was that the RBI expected the overall bad loans of banks to shoot up massively in the post-covid world, even more or less doubling from 7.5% to 14.8%, under a severe stress scenario.

A past reading of the RBI forecasts suggests that in an environment where bad loans are going up, they typically end up at levels which are higher than the severe stress level predicted by the RBI.

Given all this, there should be enough reason for worry on the banking front. But as things are turning out the dire predictions of the RBI are still not visible in the numbers. The quarterly results of a bunch of banks for the period October to December 2020 have been declared and it must be said that the banks look to be doing decently well.

In a research note, CARE Ratings points out that the bad loans rate of 30 banks which form the bulk of the Indian banking system (including the 12 public sector banks, IDBI Bank and the big private banks), stood at 7.01% as of December 2020. The rate had stood at 8.72% as of December 2019 and 7.72% as of September 2020.

In fact, when it comes to public sector banks, the bad loans rate has improved from 11.22% as of December 2019 to 9.01% as of December 2020 (This calculation includes IDBI Bank as well, which is now majorly owned by the Life Insurance Corporation of India and not the union government, and hence is categorised as a private bank).

When it comes to private banks ( a sample of 17 banks), the bad loans rate has improved from 4.87% as of December 2019 to 3.49% as of December 2020.

On the whole, these thirty banks had bad loans amounting to Rs 7.38 lakh crore on loans of Rs 105.37 lakh crore, leading to a bad loans rate of a little over 7%. Do remember, the RBI’s baseline forecast for September 2021 is 13.5%. Hence, things should have been getting worse on this front, but they seem to be getting better.

What’s happening here? The Supreme Court in an interim order dated September 3, 2020, had directed the banks that loan accounts which hadn’t been declared as a bad loan as of August 31, shall not be declared as one, until further orders.

This has essentially led to banks not declaring bad loans as bad loans. Nevertheless, the banks are declaring what they are calling proforma slippages or loans which would have been declared as bad loans but for the Supreme Court’s interim order.

A look at the results of banks tells us that even these slippages aren’t big. The proforma slippages of the State Bank of India between April and December 2020, stood at Rs 16,461 crore, which is small change, given that the bank’s total advances stand at Rs 24.6 lakh crore. When it comes to the Punjab National Bank, the total proforma slippages were at Rs 12,919 crore between April to December 2020.

Similarly, when we look at other banks, the proforma slippages are present but they are not a big number. An estimate made by the Mint newspaper suggests that India’s ten biggest private banks have proforma slippages amounting to around Rs 42,000 crore.

The 30 banks in the CARE Ratings note had total bad loans of Rs 7.38 lakh crore or a rate of 7.01 %. If this has to reach anywhere near, 13.5-14.8% as forecast by the RBI, the overall bad loans need to nearly double or touch around Rs 14 lakh crore.

The initial data doesn’t bear this out. As the RBI said in the FSR, “[With] the standstill on asset classification… the data on fresh loan impairments reported by banks may not be reflective of the true underlying state of banks’ portfolios.”

Hence, the situation will only get clearer once the Supreme Court decision comes in and the banks need to mark bad loans as bad loans. While banks are declaring proforma slippages, it could very well be that the Supreme Court interim order along with restructuring schemes announced by the RBI and the fact the Insolvency and the Bankruptcy Code remains suspended, have led to a situation where they are under-declaring these numbers.

This is not the first time something like this will happen. Around a decade back in 2011, Indian banks had started accumulating bad loans on the lending binge carried out by them between 2004 and 2010, but they didn’t declare these bad loans as bad loans immediately.

Only after a RBI crackdown and an asset quality review in mid 2015, did the banks start declaring bad loans as bad loans. There is no reason to suggest that banks are behaving differently this time around.

It is important that the same mistake isn’t made all over again. Hence, the RBI should carry out an asset quality review of banks(and non-banking finance companies) and force them to come clean on their bad loans.

A problem can only be solved once it has been identified as one.

The article originally appeared in the Deccan Herald on February 14, 2021.

Indian Banks Will Have Rs 17-18 Lakh Crore Bad Loans By September

The Reserve Bank of India (RBI) publishes the Financial Stability Report (FSR) twice a year, in June and in December. This year the report wasn’t published in December but only yesterday (January 11, 2021).

Media reports suggest that the report was delayed because the government wanted to consult the RBI on the stance of the report. For a government so obsessed with controlling the narrative this doesn’t sound surprising at all.

Let’s take a look at the important points that the FSR makes on the bad loans of banks and what does that really mean. Bad loans are largely loans which haven’t been repaid for a period of 90 days or more.

1) The bad loans of banks are expected to touch 13.5% of the total advances in a baseline scenario. Under a severe stress scenario they are expected to touch 14.8%. These are big numbers given that the total bad loans as of September 2020 stood at 7.5% of the total advances. Hence, the RBI is talking of a scenario where bad loans are expected to more or less double from where they are currently.

2) Under the severe stress scenario, the bad loans of public sector banks and private banks are expected to touch 17.6% and 8.8%, respectively. This means that public sector banks are in major trouble again.

3) In the past, the RBI has done a very bad job of predicting the bad loans rate under the baseline scenario, when the bad loans of the banking system were going up.

Source: Financial Stability Reports of the RBI.
*The actual forecast of the baseline scenario was between 4-4.1%

If we look at the above chart, between March 2014 and March 2018, the actual bad loans rate turned out to be much higher than the one predicted by the RBI under the baseline scenario. This was an era when the bad loans of the banking system were going up year on year and the RBI constantly underestimated them.

4) How has the actual bad loans rate turned out in comparison to the bad loans under severe stress scenario predicted by the RBI?

Source: Financial Stability Reports of the RBI.
*The actual forecast of the baseline scenario was between 4-4.1%

In four out of the five cases between March 31, 2014 and March 31, 2018, the actual bad loans rate turned out higher than the one predicted by the RBI under a severe stress scenario. As Arvind Subramanian, the former chief economic advisor to the ministry of finance, writes in Of Counsel:

“In March 2015, the RBI was forecasting that even under a “severe stress” scenario— where to put it colourfully, all hell breaks loose, with growth collapsing and interest rates shooting up—NPAs [bad loans] would at most reach about Rs 4.5 lakh crore.”

By March 2018, the total NPAs of banks had stood at Rs 10.36 lakh crore.

One possible reason can be offered in the RBI’s defence. Let’s assume that the central bank in March 2015 had some inkling of the bad loans of banks ending up at around Rs 10 lakh crore. Would it have made sense for it, as the country’s banking regulator, to put out such a huge number? Putting out numbers like that could have spooked the banking system in the country. It could even have possibly led to bank runs, something that the RBI wouldn’t want.

In this scenario, it perhaps made sense for the regulator to gradually up the bad loans rate prediction as the situation worsened, than predict it in just one go. Of course, I have no insider information on this and am offering this logic just to give the country’s banking regulator the benefit of doubt.

5) So, if the past is anything to go by, the actual bad loans of banks when they are going up, turn out to be much more than that forecast by the RBI even under a severe stress scenario. Hence, it is safe to say that by September 2021, the bad loans of banks will be close to 15% of advances, a little more than actually estimated under a severe stress scenario.

This will be double from 7.5% as of September 2020. Let’s try and quantify this number for the simple reason that a 15% figure doesn’t tell us about the gravity of the problem. The total advances of Indian banks as of March 2020 had stood at around Rs 109.2 lakh crore.

If this grows by 10% over a period of 18 months up to September 2021, the total advances of Indian banks will stand at around Rs 120 lakh crore. If bad loans amount to 15% of this we are looking at bad loans of Rs 18 lakh crore. The total bad loans as of March 2020 stood at around Rs 9 lakh crore, so, the chances are that bad loans will double even in absolute terms. If the total advances grow by 5% to around Rs 114.7 lakh crore, then we are looking at bad loans of around Rs 17.2 lakh crore.

6) The question is if this is the level of pain that lies up ahead for the banking system, why hasn’t it started to show as yet in the balance sheet of banks. As of March 2021, the RBI expects the bad loans of banks to touch 12.5% under a baseline scenario and 14.2% under a severe stress scenario. But this stress is yet to show up in the banking system.

This is primarily because the bad loans of banks are currently frozen as of August 31, 2020. The Supreme Court, in an interim order dated September 3, 2020, had directed the banks that loan accounts which hadn’t been declared as a bad loan as of August 31, shall not be declared as one, until further orders.

As the FSR points out:

“In view of the regulatory forbearances such as the moratorium, the standstill on asset classification and restructuring allowed in the context of the COVID-19 pandemic, the data on fresh loan impairments reported by banks may not be reflective of the true underlying state of banks’ portfolios.”

The Supreme Court clearly needs to hurry up on this and not keep this hanging.

7) Delayed recognition of bad loans is a problem that the country has been dealing with over the last decade. The bad loans which banks accumulated due to the frenzied lending between 2004 and 2011, were not recognised as bad loans quickly enough and the recognition started only in mid 2015, when the RBI launched an asset quality review.

This led to a slowdown in lending in particular by public sector banks and negatively impacted the economy. Hence, it is important that the problem be handled quickly this time around to limit the negative impact on the economy.

8) Public sector banks are again at the heart of the problem. Under the severe stress scenario their bad loans are expected to touch 17.6% of their advances. The sooner these bad loans are recognised as bad loans, accompanied with an adequate recapitalisation of these banks and adequate loan recovery efforts, the better it will be for an Indian economy.

9) At an individual level, it makes sense to have accounts in three to four banks to diversify savings, so that even if there is trouble at one bank, a bulk of the savings remain accessible. Of course, at the risk of repetition, please stay away from banks with a bad loans rate of 10% or more.

To conclude, from the looks of it, the process of kicking the bad loans can down the road seems to have started. There is already a lot of talk about the definition of bad loans being changed and loans which have been in default for 120 days or more, being categorised as bad loans, against the current 90 days.

And nothing works better in the Indian system like a bad idea whose time has come. This is bad idea whose time has come.

 

The Rs 20 Lakh Crore Bad Loans Problem of Indian Banks Hasn’t Gone Away

On December 29, 2020, the Reserve Bank of India (RBI) released the Report on Trend and Progress of Banking in India.

Like every year, the report is a treasure trove of information, especially for people like me who like to closely track the aggregate banking scene in India.

Sadly, most of this important information barely made it to the mainstream media, this, despite the fact that the health of the country’s banking sector impacts almost all of us. (This is one reason why I need your continued support).

Among other things, the report discusses the issue of the bad loans of banks in great detail. Bad loans are largely loans which haven’t been repaid for a period of 90 days or more. They are also referred to as non-performing assets or NPAs.

Let’s take a look at this issue pointwise.

1) The total bad loans of banks (public sector banks, private banks, foreign banks and small finance banks) as of March 31, 2020 stood at around Rs 8,99,802 crore. This is the lowest since 2017-18. The following chart plots the bad loans of banks over the years.

Source: Reserve Bank of India.

Despite this fall, the Indian banking sector on a whole continues to remain in a mess. We shall look at the reasons in this piece.

2) The total amount of loans written off by banks has steadily been going up over the years. In 2019-20 it peaked at Rs 2,37,876 crore. The following chart lists out the loans written off by banks over the years.

Source: Reserve Bank of India.

Basically, loans which have been bad loans for four years (that is, for one year as a ‘substandard asset’ and for three years as a ‘doubtful asset’) can be dropped from the balance sheet of banks by way of a write-off. In that sense, a write-off is an accounting practise.

Of course, before doing this, a 100 per cent provision needs to be made for a bad loan which is being written-off. This means a bank needs to set aside enough money over four years in order to meet the losses on account of a bad loan.

Also, this does not mean that a bank has to wait for four years before it can write-off a loan. If it feels that a particular loan is unrecoverable, it can be written off before four years.

So, does that mean that once a loan is written off it’s gone forever and is no longer recoverable? In India things work a little differently. In fact, almost all the bad loans written off are technical write-offs.

The RBI defines technical write-offs as bad loans which have been written off at the head office level of the bank, but remain as bad loans on the books of branches and, hence, recovery efforts continue at the branch level. If a bad loan which was technically written off is partly or fully recovered, the amount is declared as the other income of the bank. Having said that, the rate of recovery of loans written-off over the years, has been abysmal at best.

Now getting back to the issue at hand. The bad loans of banks as of March 31, 2020, have come down to some extent due to write-offs. As the Report on Trend and Progress of Banking in India points out: “The reduction in NPAs during the year was largely driven by write-offs.” Interestingly, the RBI offers the same reason for bad loans coming down in the years before 2019-20 as well.

Let’s try examining the above logic in a little more detail. The bad loans or NPAs of banks as of April 1, 2019, stood at Rs 9,15,355 crore. During the course of 2019-20, banks wrote off loans worth Rs 2,37,876 crore. Nevertheless, as of March 31, 2020, the bad loans of banks had come down to Rs 8,99,803 crore.

If we subtract the loans written off during 2019-20 from the overall bad loans of banks as of April 1, 2019, the bad loans as of March 31, 2020, should have stood at Rs 6,77,479 crore (Rs 9,15,355 crore minus Rs 2,37,876 crore). But as we see they are actually at Rs 8,99,802 crore.

What has happened here? What accounts for the significant difference? Banks have accumulated fresh bad loans during the course of the year. The net fresh bad loans (fresh bad loans accumulated during the year minus reduction in bad loans) during 2019-20 stood at Rs 2,22,323 crore. Once this added to Rs 6,77,479 crore, we get Rs 8,99,802 crore, or the bad loans as of March 31, 2020.

The point to be noted here is that banks on the whole have accumulated fresh bad loans of more than Rs 2 lakh crore during 2019-20. This is a reason to worry. It tells us that the bad loans problem of Indian banks hasn’t really gone anywhere. It is alive and kicking, unlike what many bankers, economists, India equity strategists and journalists, have been trying to tell us. Many borrowers continue to default on their loans.

The net fresh bad loans accumulated in 2018-19 had stood at Rs 1,34,738 crore. This tells us that there was a huge jump in the accumulation of fresh bad loans in 2019-20. The current financial year will see a further accumulation of bad loans due to the covid-pandemic.

3) In a February 2017 interview to Dinesh Unnikrishnan of Firstpost, Dr KC Chakrabarty, a former deputy governor of the RBI and a veteran public sector banker, had put the bad loans number of Indian banks at Rs 20 lakh crore.

As he had said:

“I’ll put the figure around Rs 20 lakh crore…One should include all troubled loans including reported bad loans, restructured assets, written off loans and bad loans that are not yet recognised.”

The trouble was not many people took Chakrabarty seriously at that point of time. Nevertheless, the Rs 20 lakh crore number doesn’t seem far-fetched at all. As mentioned earlier, the bad loans number as of March 31, 2020, stood at Rs 8,99,802 crore.

Between 2014-15 and 2019-20, the total bad loans written off by banks was Rs 8,77,856 crore. We are taking this particular time period simply because in mid 2015 the RBI launched an asset quality review and forced banks to recognise bad loans as bad loans. Up until then the banks had been using various tricks to kick the bad loans can down the road.

If we add, the bad loans as of March 2020 to bad loans written off between 2014-15 and 2019-20, we get Rs 17,77,658 crore. What does this number represent? It represents the total bad loans, the Indian banks have managed to accumulate between 2014-15 and 2019-20. And it is very close to the Rs 20 lakh crore number suggested by Chakrabarty.

Of course, this calculation does not take into account the loans which are bad loans but have not yet been recognised as bad loans. Former RBI Governor Urjit Patel in his book Overdraft—Saving the Indian Saver writes:

“In February 2020, ‘living dead’ borrowers in the commercial real-estate sector – under a familiar guise (‘a ghost from the past’, if you will) viz., ad hoc ‘restructuring’ – have been given a lifeline. It is estimated that over one-third of loans to builders are under moratorium.”

Professor Ananth Narayan of the S. P. Jain Institute of Management and Research, writing in the Mint in June 2020, said: “Banking NPA recognition remains incomplete… For a while now, RBI has allowed banks to postpone NPA recognition for some of the over Rs 8 lakh crore of MSME, MUDRA and commercial real estate loans.” The situation could only have worsened post the spread of the covid-pandemic.

If we take this into account, the bad loans of Indian banks over the last five years have amounted to much more than Rs 20 lakh crore. In that sense, Dr Chakrabarty has had the last laugh. As Chakrabarty had said in the Firstpost interview: “Unless this portion is recognised first, there will be no solution to the bad loan problem.”

Or to put it simply, how do you solve a problem without recognising that it exists.