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Last Updated : Jul 24, 2015 03:40 PM IST | Source: CNBC-TV18

Economic growth can end banks' NPLs in next 3 yrs: Experts

Dr Charan Singh, Professor of economics, IIM Bangalore and Mr Sharad Sharma, Managing Director, State Bank of Mysore talk about resolving the worry for banks, augmenting NPAs.

In the year’s first earnings season, banks have failed to post extra-ordinary numbers on the back of increasing non-performing loans (NPL). The overall banking system has a gross NPL of 4.5 percent but within that the public sector banks have a higher percent of almost 5.15 percent. So, the problem is acute for the banking system, it is even more acute for the public sector banking system.

But this should not last more than three years, say Dr Charan Singh, Professor of economics, IIM Bangalore and Sharad Sharma, Managing Director, State Bank of Mysore, as they believe overall growth is the key solution to such a sad state. Singh says “If you look at the history of Indian banking way back in 1993, these (NPLs) were around 19 percent; but once the growth started picking up, our NPLs and NPAs started coming down drastically.”

However, with the lack of equity and muted demand, the problem of iron and steel dumping have only added to the issue, says Sharad Sharma, Managing Director, State Bank of Mysore. “There are hardly any proposals which have come in for Corporate Debt Restructuring (CDR), all that has got sweated out and the project loans under 5:25 is going to expand,” Sharma adds.

Singh is of the view that stopping to fund iron and steel industries would reduce the capacity and supply which would correct prices, eventually. A solution to the ongoing trouble in the steel sector is that “we could raise the import duty and let some part of the industry die,” he says, adding, “Our PSU banks probably need accommodation and different benchmark at least for a few years.”

Raising additional concern being faced by the banking sector, Singh says: “Earlier when the public sector banks were nationalised they were prominent in different parts of the country; now all of them are everywhere and probably they are facing competition amongst themselves.”

“So, they need to determine their niche areas and they need to specialise and extend loans there,” he explains.

Below is the edited transcript of Dr Charan Singh’s and Mr Sharad Sharma's interview with CNBC-TV18's Latha Venkatesh.

Q: Is your sense that growth will ameliorate the problem often when an amount of good loans increase the percent of bad loans decreases on its own, that was our experience in 2003. Will we be able to repeat that?

Singh: This is a very pertinent issue. 13 percent is really a very high Non-Performing Asset (NPA) but I don't think there is a cause of worry because if you look at the history of Indian banking way back in 1993 we around 19 percent but once the growth started picking up our NPL, NPAs started coming down drastically.

For a very long time we were hovering around two percent. So my own feeling is firstly we should not be startled and worried about it. We have done it in the past, we can do it again. The only thing that we need to focus on is growth.

Q: But how much time do you think? The Reserve Bank's financial stress assessment said that it will rise up to September and probably fall by March, the gross NPL percent. Are you confident that within a year i.e. 10 months from now we should be able to see smaller ratios at least?

Singh: My gut feeling is that it is related to growth. Stalled projects were the major factor which lead to such high NPAs because of the previous regimes. All those bottlenecks have been cleared. One can clearly see the government is moving ahead. That sounds through change in the sentiments in the country. Once it starts translating into growth, I am not very worried it will happen in next six months or nine months but I see the positive trend and I am sure within the next two to three years we will see a total change in the NPAs system.

Latha: Three years is a little more than what the reserve Bank has at least guided or rather the Financial Stability and Development Council (FSDC) has guided. Your gut, you think a year is enough to bring the ratio down?

Sharma: I would take that with a pinch of salt because the NPL ratios coming down, that would be a derivative of the credit multiplier. Actually the issue is why we are in this current phase? Is that of course the government is concerned about the fiscal deficit part of it, so that spending, that pump priming sort of thing is not happening.

Equity is not there in the market and most of the sectors have been affected by demand if you look at the major sectors. There is a problem with iron and steel, there is dumping which is there and infrastructure and mining, so I would say maybe the sentiment may change in the current year but as far as growth of credit is concerned, maybe it will get on to next year when the NPL levels will come down to…(interrupted)

Latha: Scratch that point further, we don’t have one NPL number, we now have NPL number, we have a restructured asset and we have a refinanced 5:25. This total will look larger by March you think because 5:25 is a new baby?

Sharma: There are hardly any proposals which have come in for CDR, all that has got sweated out but yes the project loans, that 5:25 that is going to expand. You have seen in this quarter itself steel companies huge debts – Rs 30,000-40,000 crore and they are all being refinanced, so yes maybe in this calendar year there will be a little more of 5: 25 and then things will…(interrupted)

Latha: Just to get a little more colour on steel itself, steel prices if anything, have fallen in the last four weeks by about USD 20. The landed price if it was Rs 360 dollars, it has now become USD 340 because of the problems in China and the impact on commodity prices. So, a calculation by Credit Suisse indicates that even the interest outgo of a lot of companies is about USD 200 per tonne and the EBIT they make, only the stressed companies, the EBIT they make is USD 30-40.

Singh: I did read that study by the Credit Suisse and I did see the options that they had listed out. One of the options is the public sector banks especially Punjab National Bank and State Bank of India have a big exposure into the steel industry and then one of the suggestions was that we could probably stop funding these industries and obviously some of them will die.

Latha: Funding the weaker guy?

Singh: Funding the weaker guy and there will be less of capacity, less of supply and therefore the price will find its own level. This is a much more complicated issue; I would like to break it into two.

The first is we all know that there is dumping going on, we know what China is doing and how much they are subsidizing steel and that is the problem we are facing. One factor could be we could raise the import duty, that is one. The other is letting some part of the industry die, now that is where I want to bring in a new factor and I want to link it back with the rising public sector banks’ non-performing assets. Why are the public sector banks’ non-performing assets rising?

I have been mulling over this issue for quite a bit of time now and I would like to mention here the public sector banks vis-à-vis the private sector banks are a different creature. They were first nationalized in 1955, 1969, and 1980, taken away from the private sector for a very specific purpose. The purpose of course partly was financial inclusion, partly was to support employment. Now if we start telling the public sector banks to withdraw from the steel company, that is very much against the very salt for which public sector banks were created.

When the public sector banks were created, they have served a very important purpose. I can’t imagine in 2008 crisis if the public sector banks had not played the role that they had played, where would the country have been?

They played a very solid role, so therefore it is time for India to stand up and say the Basel norms were made basically for the private sector banks. Our public sector banks have served a very important social role right from inception; they probably need accommodation and different benchmark at least for a few years.

Latha: The point is I am not able to believe that all the NPL problems of the public sector banks or the higher NPL problems of the public sector banks are only because of their social purpose. I am not taking away from the social purpose that they must have served but your take on that?

Sharma: Besides a social purpose you look at it, you look at the core sector financing. Where has been the private sector bank in core sector? They started off with retail and they are little in treasury but say how many roads, how many steel plants they are into and the second part is you have to keep in mind that asset has been created; you look at a steel plant which you are saying that let it die its course.

We are talking of Rs 50,000 crore –Rs 60,000 crore of investment that has gone into that asset. Now, for the sake of WTO, you say you can’t provide production, is there other option saying that that Rs 50,000 crore of investment runs to the ground and what happens to the private sector in the public sector banks?

Q: Would you say that the public sector banks were coerced or forced into giving any of the infrastructure loans?

Sharma: I wouldn't say. As far as the public sector banks (interrupted..)

Q: It was their commercial decision that this project would succeed?

Sharma: Exactly. I would say that suasion was only in respect of the priority sector financing. So, say that is 40 percent.

Q: Which applies to private and public sector banks.

Sharma: Which applies to private and public sector. Also the only thing is focus where you were allowed to give focus for that. Whereas I have to do an SME financing or number financing which the private sector is not. So, that is not an issue but we took it as an opportunity. The economy was also growing. So, it is a process of adjustment which we are looking at and becoming a little more street smart from them.

Q: Do you think the NPL issue can be resolved by growth and by the normal course of business or do you think some surgery is needed. For instance, steel. Does it resolve itself if you leave it alone?

Sharma: I would say give it three years time and it will resolve itself.

Q: But how much money, aren't we putting good money after bad? You still think that money is well spent?

Sharma: Our bank has exposure to two or three of the companies which are currently into this thing and one or one and half years back there was no issue. There was adequate EBITDA. The only problem has come up because of the dumping part of it and besides China you also have Russia. You look at the Rouble. In the last one year the Rouble has come down by 50 percent. So, actually that is creating demand issue.

Q: When the promoters were getting USD 1000 per tonne they were not sharing their profits with us. Now when the promoters are not getting USD 1000 they are getting USD 250 why should the nation share their losses, why should they not be allowed to die? Why are you all so opposed to that argument?

Sharma: No, we are not opposed to it. There has been a change. If you look at it, the Sebi has done a change because now we can take over as we are not addressing one factor which is also the reason-the legal enforcement system and there are no takers. The whole economy there is not that there are five companies on the block and there are ten suitors because it is the other way around. So, that is also a problem.

Q: Yes, I agree POSCO just wound up its offices in Bhubaneshwar.

Singh: I am again looking at it from two different angles. One is the surgery that you are saying. The public sector banks right from their inception are a different motive unlike the profit making private sector banks. They have so much of psychology of a social sector that surgery for them, you have just seen the argument from State Bank of Mysore saying they will run them down seems so much impossible against the very ethos of the public sector bank.

The other thing that I want to bring to the front is what about the rating agencies, what about the concurrent auditors. Where are those advocates and how about those chartered accountants who certified all this. While the bankers out there in the street lending they were seeking support from all the support system. Where did they go wrong and why are they not being held accountable. This episode should be used to bring them in and say you are equally accountable, we are looking for the heads of the public sector banks, how about you all.

Q: Any reaction to that?

Sharma: I will let that pass.

Q: Do you think you need extraordinary solutions or do you think you can just wait on endlessly, maybe three-four years?

Sharma: I would say reform the legal system and we will take care of us.

Singh: My reading is this is an opportunity. This should be used, we really need to do many things but surgery is not that option. Reforms strategically done so that we don't rock the boat. We don't impact our international ratings.

Q: What would you think should be the first two or three reforms that the government should adopt?

Singh: My thoughts are there are some requirements to be used in public sector banks and PJ Nayak committee serves a very good benchmark to start launching those. The governance reforms are necessary. One of the factors why public sector banks don't perform as well as the private sector banks is the boards are very effective in the private sector banks, they are regularly monitoring it and everybody is accountable. In the public sector banks boards are sort of non-existent, I don't mean they don't exist but how effective they are. The boards need to be reconstituted.

I also think that the term of the chairman needs to be prolonged so that he is held accountable for what he is doing. Right now we are talking about capital adequacy and we are thinking of helping some of the public sector banks. I think just helping the public sector banks is not the right way, there has to be certain yardsticks and benchmarks. The top management has to be held responsible. We are flushing tax payers’ money, providing it to you, perform and have benchmarks. May be you have annual benchmarks and tell them you are accountable for it otherwise your head is off.

Q: So, even a hire and fire attitude?

Singh: I want to bring in one point which has been hurting me for very long time. You must have read it few months back, all public sector bank employees got a raise and that was surprising, not at all related to the efficiency of each of those public sector banks.

Q: The latest that we have heard from the public sector banks is that 3 percent of their profits be set aside as performance incentives. If that is indeed done and why should it be 3 percent, it could be even more. If that is accepted in principle that there is a performance incentive for the higher management plus there is a condition of tenure restrictions if performance doesn't come, a combination like this is a good idea you think?

Sharma: You had an industry wide wage settlement. Why should it be so? The point which you raised about 3 percent, that issue has been flagged by State Bank of India and the government guidelines say 1 percent, so let us see what happens over there. I would say two factors, one is the lateral recruitment part of it and that we should have flexibility where the better banks are - there is an issue, they are suffering.

The other is the compensation structure, essentially for the senior management in public sector banks, why should it be linked to the government thinking. There is a case for laterally recruiting people at the middle level or the senior level but it is not a substitute for people who have grown up through the ranks and who are good enough. If you give them a compensation structure they will stay on and they would be ready for this incentive linked sort of thing and justify that.

Q: You think an incentive linked compensation structure, performance linked compensation structure plus the ability to fire, plus the ability to laterally hire is something that the management can sell to public sector banks as a whole. Are we in that stage, politically is it possible?

Sharma: I think so, the unions are also agreeing to that and even now there is some sort of an incentive structure which is there to a certain extent. So, it has been well accepted.

Q: What Mr Sharma speaks about personnel and about performance and the quality of board issue that you raised are centred on one point, that public sector banks have 51 percent government stake and they come under the banking regulation act. If they had 49 percent stake they could be brought under the Companies Act in which case independent directors and the quality of board issue is resolved and Mrs Bhattacharya\\'s and Mr Sharma\\'s plaint that they can recruit laterally will also be resolved because the Supreme Courts point was that 51 percent gives it a public character but if it is 49 percent that problem will perhaps not arise. So, is that the solution to bring it down to 49 percent?

Singh: To my mind one has to look very clearly what is that the government wants? The public sector bank has a social sector characteristic. If public sector banks were not in the forefront Jan Dhan 16 crore accounts would not have been opened. If you want only banking system in metropolitan cities and major cities make them a private sector company.

Q: Other point that you make about the social character of banks does the fisc allow it? There was a social character to Greece and where has it landed them. Can we afford it?

Singh: Greece has been bailed three times. I want to add one more point, I think the public sector banks have the best talent that they took from the market when these people were recruited. I think they need to emphasize more on appropriate training and part of their training needs to be on major issues which are now catching up in the world and those are ethical issues.

PSU banks need to focus on one more thing, in addition to training is what are their niche areas. Earlier when the public sector banks were nationalised they were prominent in different parts of the country. Now all of them are everywhere and probably they are facing competition amongst themselves. So, they need to determine their niche areas and they need to specialise there and extend loans there.

Q: You support social character or would you think that you are better off being a commercial organisation?

Sharma: We are okay to hold our own as a commercial organisation. When I joined the bank, the compensation structure which I got was the best which was available. There was not many private sector at that point of time, so if you free up the compensation structure in the public sector banks also, I think part of the problem will be solved and lateral recruitment, if it, comes that's even better.
First Published on Jul 23, 2015 09:27 pm
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