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May 14, 2012, 12.33 PM IST | Source: CNBC-TV18

Are the worst of bad loans over for banking industry?

Experts join CNBC-TV18's Latha Venkatesh to discuss how banks will tackle with the double whammy of Basel III norms and rising NPAs.

Anand Sinha

Deputy Governor, RBI

More about the Expert...

This week, top on everyone’s mind has been the banking sector. Fourth quarter results indicate a stomach churning rise in the number of bad loans or loans which borrowers are not paying back. At such a time, the regulator Reserve Bank of India is imposing sterner rules called the Basel rules.

These rules require banks to back up their deposits and loans with more and more shareholder capital. How will banks tackle this double whammy and is the RBI right in demanding higher safeguards whatever the economy's condition? Also, how bad is the bad loan problem?

Also read: April Heat: Banks recast record Rs 6K-cr loans

RBI Deputy Governor Anand Sinha, State Bank of India Managing Director Diwakar Gupta and ICICI Bank Executive Director NS Kannan join CNBC-TV18’s Latha Venkatesh to discuss how banks will tackle with this double whammy of Basel III norms and rising NPAs.

Below is an edited transcript of their interview. Also watch the accompanying video.

Q: The bad loan numbers plus the restructured assets are beginning to look a little scary. How does the RBI look at this issue and how should investors understand this problem of restructured assets, because now it is beginning to look like eroding the net worth?

Sinha: No, it is not correct to say that so much of assets are taking away the net worth. As far as the NPAs are concerned, there is a provisioning rule and it’s not 100% unless it’s a loss asset. Therefore, it’s not really taking away the entire net worth.

To my mind, restructuring is a very legitimate and a desirable tool to deal with a stress situation. In certain parts of the world, more particularly Asia and that is where we were also prior to 2001, any restructured asset would be treated as a NPA and then after a defined period of performance according to the rescheduled installments, you could upgrade it.

Then after that, we switched over to another system, which was more prevalent in the west, where if you are fairly confident that it will be able to meet its rescheduled liabilities, then you keep it as standard. What you do is you fair value it and the loss in the net present value you provide for in the balance sheet. So this is the system that we are following now.

The question is whether restructured assets are really NPA, and I mean this from an economic sense not a classification sense. The evidence that we have so far is that roughly 15% restructured assets do turn into NPA. In some banks it is much lower, that’s what we understand, but overall 15% does turn into NPA. 85% is not NPA, therefore it should not be a threat to the economy.

You have two ways now to deal with that. Either you downgrade all the restructured assets into NPA and then take up 85-80% after the defined period into the standard asset category, or you follow the other method.

Q: Has RBI defined and allowed banks to take out their restructured assets from that category? The debate was on, but I understand you’ll have not yet allowed them to pull those assets out of restructured category?

Sinha: I think there is a bit of semantics involved over here, so let me try and clarify. As per the present dispensation, once an asset is restructured, it is to be shown as a restructured asset maybe for all times as of now. But from asset classification perspective, this categorisation doesn’t carry because then it becomes a standard asset once it has passed the probation period.

Banks made a representation to us that once a restructured standard asset has passed the test, then why continue to call it a restructured standard asset and we have agreed for that.

Q: The numbers that have come for FY12 in the form of NPLs and restructured assets for many of the banks has been quite stomach churning. Is this in your estimate the last of the bad quarters or are we going to see couple of more bad quarters?

Gupta: I think there is no denying that industry and business in general has been through trying times for two years and more. Obviously staying capacity of people varies; some people can ride it out, some people try and some people are not able to.

I think the stress that we are seeing is really systemic and it’s more because of external factors. If I were to go by the anecdotal data that we are observing, we have actually passed the worst. Q2 and Q3, were very bad and going forward we should see a significant improvement in the scenario.

Q: Would you share Mr Gupta’s optimism, and not just for ICICI since you have over 10% of banking industries assets?

Kannan: I would broadly agree with that assessment. If you look at our own numbers to start with, in the month of December and January when we came out with the results for the third quarter, I had mentioned in that point in time itself that restructuring will continue and you will see that number going up in Q4. It has pretty much panned out the way I had forecasted at that point in time.

If we look at the indicators at that point in time, we saw more references to the corporate debt restructuring mechanism. We had seen the access to capital market of some of the companies got impaired because of the equity market situation, so this was anyway coming.

But when we look at the numbers now, having put out the March results, I would agree with Mr Gupta that the bulk of restructuring is behind us. I don’t have a pipeline like I had in December to make that statement, so I would say that broadly the issue is behind us.

Q: If I ask you to extrapolate for the industry?

Kannan: My sense is since October-November, I haven’t seen large scale fresh reference to corporate debt restructuring schemes (CDR). So I would say broadly that would be true for industry as well, but we will have to wait and see how it pans out.

Only one point I want to supplement what Mr Gupta mentioned. The NPLs and restructured assets are qualitatively different, that is a point I would like to make, and that is born out of our own experience as well.

If you look at the restructured assets, it will work only when fundamentally the business model is viable and you have some short-term problems such as the cash flow issues. But if you are fundamentally going to restructure a company which is not viable, it is not going to work. It is going to get shown up as an NPA within few quarters. So it’s only a postponement of problem.

If you look at our own restructures assets, the slippage into NPL is less than 5%. So I would suggest that these two categories should qualitatively look different.

Q: A bunch of banks still indicate higher aggregate NPLs and NPLs as a percentage of total assets. So does the regulator feel confident that the worst is behind us?

Sinha: Regulators surmise is dependent on what we discuss with the banks and what independent input we have. So maybe a month or two back, we had a very elaborate exercise in which we had looked at the NPAs of the system, we had extensive talks with the banks. The sense we got was that NPAs would increase in the near-term, but after some time they would not really be on any increasing spree.

Now you cannot take out any conclusion out of the context if the macro economic situation as envisaged in the monetary policy were to change substantially. But I would believe based on that discussion, and I can also tell you we are going to have another discussion shortly, it seems that the NPAs should not be rising in a significant amount or by any significant percentage.

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