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Feb 15, 2016, 08.24 AM | Source: CNBC-TV18

Exclusive: Just how bad the bank NPA problem is

The third quarter results of banking companies have brought into public a dirty secret that everyone knew. The large amount of non-performing loans (NPA) in the banking system.

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Exclusive: Just how bad the bank NPA problem is

The third quarter results of banking companies have brought into public a dirty secret that everyone knew. The large amount of non-performing loans (NPA) in the banking system.

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Ananda Bhoumik (more)

Sr Director, India Ratings | Capital Expertise: Equity - Fundamental

The third quarter results of banking companies have brought into public a dirty secret that everyone knew. The large amount of non-performing loans (NPA) in the banking system: that is, loans that are not being paid back by the borrowers.

Sensing that banks are hiding the problem, the Reserve Bank of India, 18 months ago, asked banks to report to a newly-created central database, all loan accounts where interest is not being paid in time.

With three-four quarters of data collected, the central bank was sure of the weak borrowers. It ordered all banks to recognise as NPAs a bunch of large accounts where interest payments are routinely delayed or whose projects are stranded.

Until September, 2015 the average non-performing loans across banks was just 5.1 percent. But this quarter, the average NPA for some banks like Dena, Bank of India, PNB and IDBI Bank is up between 8 and 9 percent and for Canara, Allahabad, Andhra, Union and State Bank, it is an average 5-7 percent.

A cursory analysis suggests that at the end of the third quarter, average bad loans for the system will rise to 7 percent from 5.1 percent. That's not all. Most bankers have said the bad loans may see a similar jump in the fourth quarter.

These revelations have led to a scare in the country about how many bank loans will not be paid back and hence, how will the banks survive and lend in the future.

To obtain an answer to these questions, CNBC-TV18's Latha Venkatesh spoke to three experts: Anil Agarwal, Head of Asian Bank Research at Morgan Stanley; Ananda Bhoumik, Chief Analytical Officer at India Ratings; and Dr KC Chakrabarty, Former RBI Deputy Governor and Former Chairman of PNB.

Below is the transcript of the interview on CNBC-TV18.

Q: Ananda, let me begin with you since as the debt expert, you are going to be looking at the bank books from a very long time in terms of how much will come back. Going by what you know about the corporate sector at India Ratings, where does the public sector gross NPA stop at – at 12 percent, at 13 percent? What are you preparing for?

Bhoumik: We have already articulated and everybody knows this, a total stress assets number of about 12 percent is factored in. Where the surprises are coming from is of course, another 5-6 percent in the corporate side, which are currently classified as performing for various reasons and are not provided for at all. And these are assets, loans, exposures in sectors, they are obviously under stress, metals primarily. And our sense is that they will probably need some haircuts.

So, a double digit number is a given. It is really the additional provisioning that people are concerned about and really where that leads to is what sort of internal capital would these bags be able to generate and whether they would have sufficient capital, or any capital at all left for growth. That is the question we are grappling with.

Q: A similar question to you. A blanket question on the public sector bank numbers. We have got a bulk of the public sector bank numbers for this quarter. Is your sense also like Ananda says, that the total gross NPAs will be about 10 percent of the total book, or will it be even worse?

Agarwal: We look at total impaired loans, not just gross NPAs. So, if I look at a quarter back, the total impaired loans in the state owned banks was about 14 percent. There are banks which are running at almost 20 percent. That 14 percent will probably go up by at least 300-400 basis points over the next two years.

We also did a stress test recently, where we basically built in a scenario where it goes up by about 800 basis points compared to where we are right now. So, that 14 percent is just definitely going to go up materially whether it goes up to 16-17 or 21-22 percent, we need to wait and see how the economy recovers.

Q: Going by the pace of recognition and the kind of recognition that banks have done in the just concluded results season, what do you think will be the recognised gross NPA by the end of March?

Agarwal: Recognised gross NPAs, if you look at RBI's asset quality review (AQR) for most of the banks, it is about 2-2.2 percent. If you add up 1 percent, the gross NPA ratio will probably, for the state owned banks as a whole, increase by around 2-2.5 percent between December and March quarters.

Q: I am trying to get that figure of the gross NPA, because ultimately provisioning will have to be done on stated NPAs, not on expected NPAs. So, if that is case, what kind of a capital requirement do you envisage for the state owned banks for FY17?

Agarwal: The question is, what we do is that we look at NPAs, we look at restructured loans, because if you look at the floor of restructured loans right now, for the last couple of years, a large chunk of the restructured loans are turning bad. And what we do is we look at the restructured loans, which are coming out of restructuring and 60 percent of those loans actually becoming NPAs...

Q: Actually, it is only between about 30 percent at worst or 40 percent at worst of the restructured loans that have become NPAs. So, should you count the entire restructured book as potential NPAs?

Agarwal: No, we do not count the entire restructured book as potential NPAs. Actually, if we look at the loans which are exiting the restructuring process, most of the banks right now are reporting 60-80 percent of their loans which are exiting restructuring process, becoming NPAs because if you look at 20-30 percent on the outstanding stock, that is not the right number because a lot of these restructured loans have moratorium periods of 2-3 years. So, you need to look at what is coming out of restructured loans. 

When it comes out of restructured loans, is it getting upgraded or downgraded. And depending on the bank, this quarter is different because of the special drawing rights (SDR) stuff, because most of the restructured loans are being, whichever, whatever is exiting is basically going through the SDR process, so they will become NPAs two years later.

But, if you look at the exit from restructuring and that is the key number in my view, 60-80 percent of all the exits from restructuring are turning bad. And that applies to private and state owned banks. So, a lot of restructured loans are turning bad. As a result of which, when the time comes, they will have to make provisioning on those restructured loans also.

So, in my view, the state owned banks, if I assume that they need to achieve 9.5-10 percent comment equity tier I (CET1) ratio, they need to grow their loan book at anything between 7-10 percent depending on how small or big the bank is. Then to achieve that kind of Tier I ratio by March, 2019 which is the end of Basel  III, state owned banks will need about USD 40 billion of capital. And, the thing is the more the delay in capital infusion, the bigger the hit will be because, that means these banks are not able to grow, so more corporates will turn bad. So, it is not a static number, it will keep growing.

Q: That is a sizeable amount of money that you are asking for in terms of capital. In rupee terms, it will be about Rs 2.5 lakh crore, that you are talking of in terms of capital. What is your bill? And I want to know more the FY17 bill.

Bhoumik: FY17 is going to be relatively modest. You see, the complication here is you were discussing provisions is not so much as what the addition to the reported NPAs are. The other complication has been that this year and rightly so, some of these recognitions are being provided for as if in they are in the doubtful category. So, RBI has required them to be classified from the day they went under stress and not from recognition. So, therefore, some of these recent recognitions are requiring higher levels of provision which is what they should be.

The FY17 requirements are relatively more modest. But, FY18 and FY19 are significantly stepped up. At FY 17, depending upon which way you look at it, the growth numbers you look at, we sense a requirement between Rs 25,000 crore and Rs 30,000 crore. That sounds modest.

Q: Rs 25,000-30,000 crore?

Bhoumik: Of equity contribution from the government, so I am just looking at what the government is required to contribute. On top of that, there is an additional 25,000 that the banks need to raise by way of ET1 capital. So, somebody has got to find a market for that. If that is not supplied in, then obviously, that would probably need to be contributed by way of equity and then of course, there is a balance 20-25 percent number which is expected to be raised to from the equity markets which is not supportive at all.

So, therefore, in terms of the actually billing, that number may actually double from what the ask is. And this is without even considering the additional provisioning that may be required from the bottom up study that we did which suggests that there is an additional haircut that the banks need to take on some of the currently performing numbers. So, the bill is going to mount up.

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