Banking Central | How clean are the books of our banks?

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Banks have waded past the worst phase of the last bad loan cycle at this point, at least that’s the sense one gets from the numbers reported. A loan becomes bad if there is no repayment of interest for a period of 90 days. But, as we find it, much of this improvement is due to sizeable loan write-offs in the recent years.

Consider this: According to official data, loans worth over Rs 8 lakh crore has been written off in the last decade. Also, there are cases that have been pushed to the bankruptcy courts (typically large corporate NPAs) that too helped lenders show a better balance sheet.

What is a loan write-off? A loan is written off when all hopes of recovery is lost and banks just want to take the burden off their books and start afresh. But, this comes at a price. Every written off loan needs to be provided fully which translates into impact on profitability.

But, after the write off, banks have a much cleaner balance sheet. Percentage of gross non-performing assets (GNPAs) to total loan book declines and hence the NPA figures fall. This doesn’t mean all is well. Banks have taken a hit already. So one needs to see the improvement in current NPA numbers in this backdrop.

According to the Reserve Bank of India (RBI) financial stability report for June 2022, the gross non-performing asset (NPA) ratio of banks fell to six-year low of 5.9 percent in March 2022. The net non-performing assets (NNPA) ratio fell to 1.7 percent in March 2022.

But, is real recovery happening? Not in a big way, really. Take the case, for example, the progress (or lack of it) of the corporate loan resolution at Insolvency and bankruptcy courts. According to a CARE analysis, the cumulative recovery rate under the insolvency resolution processes of debt-ridden companies declined to 30.18 percent at the end of the September quarter, indicating that the lenders took more haircut on their exposure.

The recovery rate has fallen steeply from a peak of 43 percent in Q1 FY20. Of the Rs 7,90,626.2 crore claims from the financial creditors admitted by various benches of the National Company Law Tribunal (NCLT), only Rs 2,43,452.5 crore or 30.18 percent have been recovered till the end of Q2 FY23, as per an analysis of the IBBI data done by Care Ratings.

In fact, distressed companies liquidated under the bankruptcy code have far outnumbered those rescued till now. Beginning December 2016 till March 2022, 47 percent of corporate insolvency processes went into liquidation, compared with 14 percent that ended in a resolution plan, according to the data.

To quantify, out of a total of 5,258 corporate insolvency proceedings initiated under the code till March, only 3,406 have been closed. Among those closed, as many as 1,609 proceedings have ordered liquidation, while 480 have ended in approval of resolution plans. The overall recovery rate implies a haircut of around 70 percent for the lenders.

So, the point is the cleaner books of banks are largely a product of smart adjustments rather than genuine improvement in economic conditions.

So, what next?

The next round of NPAs can happen, according to experienced industry watchers, over the next few years if economic recovery doesn’t happen as expected. Every cycle of aggressive lending typically succeeds a phase of bad loan spike if economies do not fare well and unemployment rises.

Right now, we are probably at a phase of aggressive credit growth. On a year-on-year basis, non-food bank credit registered a growth of 16.9 percent in September 2022 as against 6.8 percent a year ago. Credit to industry climbed 12.6 percent in September 2022 as against 1.7 percent in September 2021, while the personal loans segment grew by 19.6 percent in September 2022 - up from 13.2 percent a year ago.

Even education loans are going up pretty fast. According to the Reserve Bank of India (RBI) data, banks’ education loans grew at 12 percent in the 12 months ended September 30, 2022. This is compared with just 1 percent growth in the previous 12 months. If one looks at the variation in the financial year, so far, growth in education loans stood at 8.2 percent compared with 2.3 percent in the previous comparable period. In absolute terms, outstanding education loans of Indian banks stood at Rs 89,537 crore as on September 23, 2022, compared with Rs 79,917 crore a year ago.

Some of these growth figures can also be partly attributed to base effect but what we know for sure is that banks have started loosening their purse strings generously after a gap of few years of extreme caution.

There is a risk side to it and a fairly big one.

The economy is not doing well, really, at least now. India's Gross Domestic Product (GDP) growth is expected to more than halve to 6.3 percent in the second quarter of 2022-23 from the first quarter, according to the median of estimates by 15 economists polled by Moneycontrol. The Indian economy had grown by 13.5 percent in April-June  but that’s largely due to a favourable base effect.

On the other hand, unemployment is on the rise. The unemployment rate in India rose to 7.77 percent in October compared to a four-year low of 6.43 percent in September, data from Centre for Monitoring Indian Economy (CMIE) show.

In this backdrop, an aggressive pick-up in credit growth could backfire in later years if the economy doesn’t do well and banks may have to get ready for another round of bad loan cleanup exercise, something like what Raghuram Rajan-led RBI had initiated in 2015-2016 under the asset quality review. Only time will tell.