The Reserve Bank of India(RBI) released the Financial Stability Report on December 23, 2015. One of the key themes in this report was the fact that large borrowers are the ones who have landed the banking sector in trouble. As the RBI governor Raghuram Rajan wrote in the foreword to the report: “corporate sector vulnerabilities and the impact of their weak balance sheets on the financial system need closer monitoring.”
That is a euphemistic way of saying that corporates are essentially responsible for the rising bad loans of banks. As on September 30, 2015, the bad loans (gross non-performing advances) of banks were at 5.1% of total advances [i.e. loans] of scheduled commercial banks operating in India. The number was at 4.6% as on March 31, 2015. This is a huge jump of 50 basis points in a period of just six months. One basis point is one hundredth of a percentage.
What is the problem here? The inability of large borrowers to continue repaying the loans they have taken on in the years gone by. As on September 30, 2015, loans to large borrowers made up 64.5% of total loans. On the other hand, bad loans held by large borrowers amounted to 87.4% of total bad loans.
What this means is that for every Rs 100 of loans given by banks, Rs 64.5 has been given to large borrowers. At the same time of every Rs 100 of bad loans, large borrowers are responsible for Rs 87.4 of bad loans. Hence, large borrowers are clearly responsible for more bad loans.
As on March 31, 2015, bank loans to large borrowers made up 65.4% of total bank loans. At the same time, the bad loans of large borrowers constituted 78.2% of the total bad loans. What this means is that for every Rs 100 of loans given by banks, Rs 65.4 was given to large borrowers. At the same time of every Rs 100 of bad loans, large borrowers were responsible for Rs 78.2 of bad loans. This has since jumped to Rs 87.4 for every Rs 100 of bad loans.
What these numbers clearly tell us is that in a period of six months the situation has deteriorated big time and large borrowers have been responsible for it. As the RBI Financial Stability Report points out: “While adverse economic conditions and other factors related to certain specific sectors played a key role in asset quality deterioration, one of the possible inferences from the observations in this context could be that banks extended disproportionately high levels of credit to corporate entities / promoters who had much less ‘skin in the game’ during the boom period.”
What does this mean? Banks gave loans to corporates/promoters who had put very little of their own money in the project they had borrowed money for. Banks essentially gave more loans than they actually should have, given the amount of capital the promoters put in. And this is now proving to be costly for them.
In fact, lending to industry forms a major part of the stressed loans of banks. Stressed loans are essentially obtained by adding the bad loans and the restructured loans of banks. A restructured loan is a loan on which the interest rate charged by the bank to the borrower has been lowered. Or the borrower has been given more time to repay the loan i.e. the tenure of the loan has been increased. In both cases the bank has to bear a loss.
As the RBI report points out: “Sectoral data as of June 2015 indicates that among the broad sectors, industry continued to record the highest stressed advances ratio of about 19.5 percent, followed by services at 7 per cent. The retail sector recorded the lowest stressed advances ratio at 2 per cent. In terms of size, medium and large industries each had stressed advances ratio at 21 per cent, whereas, in the case of micro industries, the ratio stood at over 8 per cent.”
Lending to the retail sector (i.e. you and me) continues to be the best form of lending for banks. The stressed loans ratio in this case is only 2%. This means that for every Rs 100 lent by banks to the retail sector (home loans, car loans, personal loans and so on), only Rs 2 is stressed.
Why is this the case? For the simple reason that it is very easy for banks to go after retail borrowers who are no longer in a position to repay the loans they have taken on. Further, there is no political meddling when it comes to loans to retail borrowers, hence, the lending is anyway of good quality.
In comparison, lending to industry has a stressed loans ratio of 19.5%. This means for every Rs 100 that the banks have lent to industry, Rs 19.5 is stressed i.e. it has either been defaulted on or has been restructured. Interestingly, even within industry, the situation with the micro industries is not as bad as the medium and the large industries.
The large industries have a stressed loans ratio of 21% i.e. for every Rs 100 lent to large industries by banks, Rs 21 has either been defaulted on or has been restructured. In case of micro industries, the number is at 8%. This is because banks can unleash their lawyers on the small industries in case the loan is in trouble. They can’t do the same on large borrowers. And even if they do it does not have the same impact.
Five sectors have been responsible for a major part of the trouble. These are mining, iron & steel, textiles, infrastructure and aviation. These “together constituted 24.2 per cent of the total advances [i.e. loans] scheduled commercial banks as of June 2015, contributed to 53.0 per cent of the total stressed advances.” “Stressed advances in the aviation sector6 increased to 61.0 per cent in June 2015 from 58.9 per cent in March, while stressed advances of the infrastructure sector increased to 24.0 per cent from 22.9 per cent during the same period.”
To conclude, when it comes to the bad loans of banking, the big boys are the bad boys who are responsible for a majority of the mess.
The column originally appeared on The Daily Reckoning on January 5, 2016