The Banking Ordinance is no magic pill for ailing banks

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Recently, the government promulgated the Banking Regulation(Amendment) Ordinance, 2017, to tackle the huge amount of bad loans that have accumulated in the Indian banking system in general and the government owned public sector banks in particular. Bad loans are essentially loans in which the repayment from a borrower has been due for 90 days or more.

This Ordinance is now being looked at the magic pill which will cure the problems of Indian banks. Will it?

The Ordinance essentially gives power to the Reserve Bank of India(RBI) to give directions to banks for the resolutions of bad loans from time to time. It also allows the Indian central bank to appoint committees or authorities to advise banks on resolution of stressed assets.

The basic assumption that the Ordinance seems to make is that the RBI knows more about banking than the banks themselves. This doesn’t make much sense for the simple reason that if the RBI was better at banking than the banks themselves, it would have been able to identify the start of the bad loans problem as far back as 2011, which it didn’t.

Over and above this, this is not the first time that Indian banks have landed in trouble because of bad loans. They had landed up in a similar situation in the early 1980s and the early 2000s as well, and the RBI hadn’t been able to do much about it.

In fact, at the level of banks, many banks have been more interested in postponing the recognition of the problem of bad loans. This basically means they haven’t been recognising bad loans as bad loans. One way of doing this is by restructuring the loan and allowing the borrower a moratorium during which he does not have to repay the principal amount of the loan. In some cases, even the interest need not be paid. In some other cases, the tenure of the loan has been increased. In many cases this simply means just pushing the can down the road by not recognising a bad loan as a bad loan.

Why have banks been doing this? The Economic Survey gives us multiple reasons for the same. Large debtors have borrowed from many banks and these banks need to coordinate among themselves, and that hasn’t happened. At public sector banks recognising a bad loan as a bad loan and writing it off, can attract the attention of the investigative agencies.

Also, no public sector banker in his right mind would want to negotiate a settlement with the borrower who may not be able to repay the entire loan, but he may be in a position to repay a part of the loan. As the Economic Survey points out: “If PSU banks grant large debt reductions, this could attract the attention of the investigative agencies”. What makes this even more difficult is the fact that some of defaulters have been regular defaulters over the decades, and who are close to politicians across parties.

Hence, bankers have just been happy restructuring a loan and pushing the can down the road.

Over and above this, writing off bad loans once they haven’t been repaid for a while, leads to the banks needing more capital to continue to be in business. In case of public sector banks this means the government having to allocate more money towards recapitalisation of banks. There is a limit to that as well.

Also, a bigger problem which the Economic Survey does not talk about is the fact that the rate of recovery of bad loans has gone down dramatically over the years. In 2013-2014, the rate of recovery was at 18.8 per cent. By 2015-2016, this had fallen to 10.3 per cent. Hence, banks were only recovering around Rs 10 out of the every Rs 100 of bad loans defaulted on by borrowers. This is clear reflection of the weak institutional mechanisms in India, which cannot change overnight.

Also, many of the companies that have taken on large loans are no longer in a position to repay. As the Economic Survey points out: “Cash flows in the large stressed companies have been deteriorating over the past few years, to the point where debt reductions of more than 50 percent will often be needed to restore viability. The only alternative would be to convert debt to equity, take over the companies, and then sell them at a loss.”

The first problem here will be that many businessmen are very close to politicians.
Hence taking over companies won’t be easy. Over and above this, it will require the government and the public sector banks, working with the mindset of a profit motive, like a private equity or a venture capital fund. And that is easier said than done.

The column originally appeared in the Daily News and Analysis on May 22, 2017.

Bank Lending Down by Half in 2016-2017

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On April 6, 2017, the Reserve Bank of India(RBI) published the latest Monetary Policy Report. Buried on page 40 of the report is a very interesting data point which rather surprisingly hasn’t been splashed on the front pages of the pink papers as yet.

In 2016-2017, Indian banks gave out total non-food credit worth Rs 3,65,500 crore. Banks give working-capital loans to the Food Corporation of India(FCI) to carry out its procurement actions. FCI primarily buys rice and wheat directly from Indian farmers using the loans it takes from banks. When these loans are subtracted from overall loans given out by banks, we arrive at non-food credit.

In 2015-2016, the total non-food credit of banks had amounted to Rs 7,02,400 crore. What this means that non-food credit came crashing down by close to 48 per cent during the course of 2016-2017, the last financial year. To put it simply, this basically means that in 2016-2017, banks lent around half of what they had lent out in 2015-2016.

The important question is why has this happened? A major reason for this is that the total outstanding loans to industry has actually shrunk in 2016-2017(between April 2016 and February 2017, which is the latest data available) by Rs 60,064 crore. This basically means that Indian banks on the whole, did not give a single new rupee to industry as a loan during the course of 2016-2017.

And the reason for that is very straightforward. Over the years many corporates have defaulted on the loans they had taken on from banks, in particular public sector banks. And this explains why banks are not in the mood to lend to corporates anymore. As they say, one bitten twice shy.

In fact, as on December 31, 2016, the gross non-performing assets or bad loans of public sector banks had stood at Rs 6,46,199 crore, having jumped by 137 per cent over a period of two years. Bad loans are essentially loans in which the repayment from a borrower has been due for 90 days or more. The bad loans of private banks as on December 31, 2016, stood at Rs 86,124 crore.

A major chunk of these defaults has come from corporates. As of March 31, 2016, the total corporate bad loans of public sector banks had stood at Rs 3,36,124 crore or 11.95 per cent of the total loans given out to corporates. It formed a little more than 62 per cent of the total bad loans. This is the latest number I could find in this context. There is enough anecdotal evidence to suggest that the situation has worsened since then.

Given this, as I said earlier, banks are not in the mood to lend to corporates. Hence, their overall lending for 2016-2017 has shrunk by half in comparison to 2015-2016.

The interesting thing is that while Indian banks may not be lending as much, the other sources of funding haven’t really dried up. Private placements of debt jumped up majorly in 2016-2017 in comparison to 2015-2016 and so did issuance of commercial paper by non-financial entities. Over and above this, the foreign direct investment into the country continued to remain strong. During 2016-2017, FDI worth Rs 2,53,500 crore came into the country. This was more or less similar to the amount that came in 2015-2016.

In total, the flow of financial resources to the commercial sector stood at Rs 1,262,000 crore, the RBI estimate suggests. This is around 12.1 per cent lower than the last year. Hence, the overall availability of money has shrunk but the situation is not as bad as bank lending data makes it out to be.

Basically, while banks may not want to lend to corporates, there are other sources of funding that do remain strong. Having said that, a fall of more than 12 per cent in total flow of financial resources to the commercial sector, is not a good sign on the economic front. This can only be corrected only after banks come back into the mood to lend to corporates. And that will only happen when banks get into a position where they are able to recover back from corporates a significant chunk of their bad loans. As of now no such signs are visible.

 

The column originally appeared in the Daily News and Analysis on April 25, 2017

Public Sector Banking is Now in a Bigger Mess

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The break at writing the Diary turned out to be much longer than I had expected. The main reason for it will become obvious in the days to come.

A lot has happened during this period, including the Modi government’s defence of demonetisation, which has grown by leaps and bounds. Nevertheless, I thought of giving writing on demonetisation a break for the first piece for the Diary in 2017.

One thing that has got side-lined in the entire discussion on demonetisation is the fact that Indian public sector banks continue to remain in a mess. In fact, as we shall see the mess has only grown bigger in the recent past. As the RBI Financial Stability Report for December 2016 points out: “The stress on banking sector, particularly the public sector banks (PSBs) remain significant… PSBs as a group continued to record losses.”

The gross non-performing assets ratio or the bad loans of the PSBs, increased to 11.8 per cent as on September 30, 2016. This is a whopping increase
220 basis points from 9.6 per cent as of March 31, 2016. One basis point is one hundredth of a percentage.

The overall stressed assets of public sector banks jumped to 15.8 per cent of total loans. It had stood at 14.9 per cent as on March 31, 2016.

The stressed asset figure of 15.8 per cent was obtained by adding bad loans of 11.8 per cent with restructured assets of 4 per cent. This basically means that for every Rs 100 that the PSBs have given out as a loan, Rs 15.8 are in a dodgy territory, on an average.

Out of every Rs 100 of loans made by the banks, borrowers have stopped repaying loans worth Rs 11.8. Over and above that loans worth Rs 4 for every Rs 100 of loans given by the banks have been restructured. A restructured loan essentially implies that the borrower has been given a moratorium during which he does not have to repay the principal amount. In some cases, even the interest need not be paid. In some other cases, the tenure of the loan has been increased.

This is clearly a reason to worry. Nevertheless, there is a small good sign here as well. Unlike earlier, when banks were using the restructuring route to not recognise bad loans, that doesn’t seem to be happening much now. As on March 31, 2016, the restructured loans had stood at 4.9 per cent of total loans. This has fallen to 4 per cent of total loans as of September 30, 2016. Banks are now recognising bad loans as bad loans. The first step towards solving a problem is recognising that it exists.

The increase in bad loans of public sector banks can also be seen in the bad loans figure of large borrowers. The Reserve Bank of India categorises large borrowers as borrowers with an outstanding loan amount of Rs 5 crore or more. The Financial Stability Report points out: “The large borrowers registered significant deterioration in their asset quality.”

However, the report does not mention a clear bad loans figure for the large borrowers. As the RBI Financial Stability Report for June 2016 pointed out: “The gross non-performing assets(GNPA) ratio of large borrowers increased sharply from 7.0 per cent to 10.6 per cent during September 2015 to March 2016.” This basically means that as on September 30, 2016, the gross non-performing assets ratio or the bad loans of banks would have stood at greater than 10.6 per cent.

If we look at Figure 1, the bad loans ratio for the large borrowers seems to be greater than 15 per cent as of September 30, 2016.

Figure 1:

 

This basically means that the large borrowers are the ones who continue to create problems for public sector banks. Take a look at Figure 2.

Figure 2:

The large borrowers form 56.5 per cent of the total loans given by banks. Nonetheless, they form 88.4 per cent of the total bad loans of banks. And this is where the basic trouble is. The rate of recovery of bad loans by banks is also not good enough.

As a recent report in The Indian Express points out: “The rate of recovery of non-performing assets (NPAs) was 10.3 per cent, or Rs 22,800 crore, out of the total NPAs of Rs 221,400 crore during fiscal ended March 2016, against Rs 30,800 crore (12.4 per cent) of the total amount of Rs 248,200 crore reported in March 2015, data from the Reserve Bank of India (RBI) has said.”

Indeed, what is worrying is that the RBI points out that the bad loans of the PSBs could increase further. As the report points out: “Among the bank groups, PSBs may continue to register the highest GNPA ratio. Under baseline scenario, the PSBs’ GNPA ratio may increase to 12.5 per cent in March 2017 and then to 12.9 per cent in March 2018 from 11.8 per cent in September 2016, which could increase further under a severe stress scenario.”

Interestingly, the June 2016 Financial Stability Report had pointed out: “Among the bank-groups, PSBs may continue to register the highest GNPA ratio. Under the baseline scenario, their GNPA ratio may go up to 10.1 per cent by March 2017 from 9.6 per cent as of March 2016. However, under a severe stress scenario, it may increase to 11.0 per cent by March 2017.”

We have already crossed the severe stress level in September 2016, something which was forecast only for March 2017. This basically means that the government will have to keep pumping more and more capital into these banks in the years to come in order to keep them going. And that means a lot more money of taxpayers will essentially go down the drain.

Postscript: I would like to thank all readers who supported my recent petition to the President. I am in the process of planning the dispatch of the responses received to the President.

The column was originally published on Equitymaster on January 11, 2017

 

Why Do People Still Have Deposits in Indian Overseas Bank and UCO Bank?

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That we are financially illiterate nation is a given. But even with this disclaimer I am sometimes amazed at how lackadaisical people are when it comes to their money.

Take the case of two public sector banks: a) Indian Overseas Bank b) UCO Bank. Recently, both the banks declared results for the three-month period ending June 30, 2016. As of June 30, the bad loans of Indian Overseas Bank amounted to 20.48 per cent. And that of UCO Bank were at 17.19 per cent.

This basically means that close to one-fifth of the loans given by these banks have not been repaid. The question is how do these banks or for that matter any bank, give loans? A bank raises deposits and then gives out those deposits as loans.

Of course, if the loans of a bank are not being repaid, it’s chances of returning deposits are also low. At least, that is how things should work in theory. But that is not the case primarily because everyone knows that a government is not going to let a public sector bank go bust. (Actually, the government won’t let even a private sector bank go bust, but that is a story we will leave for another day).

And this explains why people still have their money deposited with these banks. Take the case of Indian Overseas Bank. As on June 30, 2016, the total deposits with the bank stood at Rs 2.18 lakh crore, in comparison to Rs 2.32 lakh crore a year earlier. Now that is a fall of 5.85 per cent.

This drop is extremely marginal when one takes into account the fact that the bad loans of the bank have more than doubled during the same period. As on June 30, 2015, the bad loans of the bank had stood at 9.40 per cent of its total advances. What this clearly tells us is that the smart money has started to move out of the bank. But the bulk of the lot continue to hold on to their deposits in the bank.

How do things look for UCO Bank? I couldn’t find the deposits of the bank as on June 30, 2016, and hence, have worked with March 31, 2016, numbers, which are good enough to make the point I am trying to make.

As of March 31, 2016, the total deposits of UCO Bank were at Rs 2.07 lakh crore, down from Rs 2.14 lakh crore from a year earlier. This is a meagre fall of 3.4 per cent. During the same period, the bad loans of the bank have jumped from 6.76 per cent to 15.43 per cent.

While the investors in the stocks of these banks have realised the true situation that these banks are in, the same cannot be said about the depositors. The explanation for this is fairly straightforward. Most depositors do not keep track of the state of the bank they have deposited their money in, especially if it happens to be a public sector bank.

The de facto assumption is that money deposited in a public sector bank is safe, which it is. Nevertheless, if at all there is trouble, there might be transitional problems and during that period liquidity of these deposits might be an issue.

Also, for all the risk that depositors are taking on by investing in these banks, what is the extra return that they are earning? The interest on fixed deposits of UCO Bank for a period of one year or more vary between 7.25 per cent and 7.5 per cent. The interest rates on fixed deposits of Indian Overseas Bank for a similar period vary between 7 per cent and 7.25 per cent.

The State Bank of India, the largest public sector bank, offers interest rates between 7 per cent and 7.5 per cent, for fixed deposits of one year or more. Hence, the State Bank of India offers more or less the same interest rate as Indian Overseas Bank and UCO Bank, do.

At the same time, it is a much safer bank to have your deposits in given that its bad loans as on June 30, 2016, stood at 6.49 per cent of its total advances. They had stood at 4.29 per cent as on June 30, 2015.

So, the bad loans of State Bank of India are lower than that of both Indian Overseas Bank as well as UCO Bank. At the same time, they have gone up at a much slower pace. In case both Indian Overseas Bank and UCO Bank, the bad loans have more than doubled over the last one year. This is clearly not the case with State Bank of India.

Hence, even those depositors who like to hold their deposits in government owned banks, the State Bank of India, is a much safer bet. Also, it is the biggest government bank and the government has the most interest in keeping it going.

The only place human beings are known to be rational are in theoretical economics. In real life they clearly not. The above example clearly shows us that. The reasons of people holding on to deposits in Indian Overseas Bank and UCO Bank can be multiple

The first, is that they don’t know that the banks are in a bad shape. The second, is that they do know that banks are in a bad shape, but they also know that government banks don’t fail. The third, is that they have always had their deposits in these banks and are friendly with the people who run the branch they have their deposits in.

Nevertheless, none of these reasons is a rational one because the fixed deposits of these two banks do not pay a higher rate of return for the extra risk that the people are taking on.

The column originally appeared in Vivek Kaul’s Diary on August 16, 2016

In the END, the Govt will have NO OPTION but to SELL the Public Sector Banks

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One of the themes I have regularly explored is the mess that public sector banks are in. Some fresh data coming in shows that the situation continues to be hopeless. The following table shows the loan-write-offs of the various public sector banks over the last decade.

YearWrite-offs

(in Rs crore)

 
2015-201659,547 
2014-201552,542 
2013-201434,409 
2012-201327,231 
2011-201215,551 
2010-201117,794 
2009-201011,185 
2008-20097,461 
2007-20088,019 
2006-20079,189 

Source: Reserve Bank of India

The above table clearly shows that the loan write-offs of public sector banks have clearly gone up majorly over the last ten years. Banks essentially raise deposits to give out loans. These loans are typically (though not always) given against a collateral. This is done, in order to ensure that if the borrower stops repaying the loan, then the collateral can be seized and the outstanding loan amount can be collected.

But things don’t always turn out like that. Banks are not able to collect every loan that is defaulted on. In the end, they need to write-off these uncollected loans. As can be seen from the above table, the write-offs of public sector banks in India have gone up dramatically over the years. What this tells us is that over the years, banks have been unable to collect a greater amount of loans that have been defaulted on. Indeed, this is a worrying trend.

 

Now take a look at the following table. This shows that the banks are able to recover some amount of loans that have been defaulted on.

Year   Recovery (in Rs crore)
2015-201639,534
2014-201541,236
2013-201433,698
2012-201319,832

Source: Reserve Bank of India

What the above table tells us is that the recovery of defaulted loans has been lower than the write-offs in each of the last four financial years. What this clearly tells us is that the ability of public sector banks to recover defaulted loans is limited. In fact, between 2013-2014 and 2015-2016 the ratio of write-offs to recovered loans has gone up from 1.02 to 1.51. This is not a healthy trend.

Let’s look at the numbers of the State Bank of India group (i.e. the State Bank of India and its associate banks).

YearWrite-offs (in Rs crore)Recovery (in Rs crore)Ratio (Write-offs/Recoveries)
2015-201620,87311,0211.89
2014-201524,05216,0201.50
2013-201414,67010,5331.39
2012-20136,8806,6891.03

 

What the above table clearly shows us is that write-offs as a proportion of recoveries have gone up over the years. What is true for the public sector banks as a whole is also true for the SBI group.

In this scenario of increasing write-offs in comparison to recoveries, it is hardly surprising that the government has to keep putting money into these banks. Earlier this month, on July 19, the government decided to pump in Rs 22,915 crore, into thirteen public sector banks.

S. No.Name of BankAmount (in crore)
1Allahabad Bank44
2Bank of India1784
3Canara Bank997
4Central Bank of India1729
5Corporation Bank677
6Dena Bank594
7Indian Overseas Bank3101
8Punjab National Bank2816
9State Bank of India7575
10Syndicate bank1034
11UCO Bank1033
12Union Bank of India721
13United Bank of India810
 Total22915

It needs to be pointed out here that the government has already infused Rs 1.02 lakh crore of capital between 2009 and September 2015 into public sector banks. For 2016-2017, the government has budgeted Rs 25,000 crore to be invested in public sector banks.

In fact, as the finance Arun Jaitley, said in his February 2016, budget speech: “If additional capital is required by these Banks, we will find the resources for doing so. We stand solidly behind these Banks.” This was Jaitley’s way of saying that the government will do whatever it takes to keep these banks going.

Of the Rs 25,000 crore allocated towards recapitalization of banks at the beginning of the financial year, Rs 22,915 crore has been allocated to thirteen banks. Of this, the State Bank of India gets Rs 7,575 crore or a third of the allocated amount. 75 per cent of the allocated amount will be released immediately to banks and the remaining will be released later, depending on the performance of the bank.

As of March 31,2016, the total bad loans of public sector banks stood at Rs 4,76,816 crore or 9.32 per cent of the total advances. As of March 31, 2015, the total bad loans had stood at Rs 2,67,065 crore or 5.43 per cent of the total advances. This basically means that during the course of one year, the bad loans have jumped up dramatically. The only reason for this is that, the public sector banks up until now were not recognising bad loans as bad loans. Now the Reserve Bank of India is forcing them to do that.

As we have seen earlier the recovery rate of bad loans of public sector banks is very low. Given this, a significant portion of the bad loans will have to be written-off in the years to come. Hence, Rs 22,915 crore of recapitalization is not going to be anywhere near enough.

Further, as per the Indradhanush Reforms released in August 2015, the capital requirement of public sector banks up to March 31, 2019, has been estimated to be around Rs 1,80,000 crore. Of this, the government will invest Rs 70,000 crore and the remaining the banks are expected to raise from the market.

As the bad loans number of Rs 4,76,816 crore tells us, Rs 70,000 crore will turn out to be a terrible underestimate. In fact, some other forecasts, are way bigger than what the government is estimating.

The PJ Nayak Committee has estimated that the that banks will need a capital of Rs  5.87 lakh crore. The committee further assumes that if the government puts in 60 per cent of the amount then it will need Rs 3.5 lakh crore.

Another estimate made by Viral Acharya of Stern School of Business and Krishnamurthy V Subramanian of the Indian School of Business, in a research paper titled State intervention in banking: the relative health of Indian public sector and private sector banks, suggests bigger numbers.

The professors come up with three scenarios. In what they call the extremely prudent scenario they feel that the public sector banks will need around Rs 9,97,400 crore of capital. In the less prudent scenario, banks will need Rs 6,53,300 crore of capital. In the least prudent scenario banks would need Rs 5,12,300 crore of capital.

It needs to be pointed out that not all of this capital will be required because of bad loans. Basel III norms which require banks to hold greater amount of capital against the loans they give out, come into effect from April 1, 2019. Banks need to prepare to move towards Basel III norms.

In a recent research report Suresh Ganapathy of Macquarie wrote that banks need at least Rs 1.6 lakh crore over the next three years, compared to the Rs 45,000 crore that the government plans to invest.

If the government decides to fund this money out of its own pocket, the fiscal deficit is likely to go through the roof. Fiscal deficit is the difference between what the government earns and what it spends.

In the end the government will have no option but to sell some of these banks. The thing is it will take its own sweet time doing the same.

To conclude, the mess in public sector banks, is not going away any time soon.

The column originally appeared on Vivek Kaul’s Diary on July 29, 2016