Lending, at the end of the day, should be a commercial decision and is a sole prerogative of the individual entities, it is better left that way in the broader interest of the system
Eleven out of 21 listed banks in the country are under Prompt and Corrective Action (PCA) framework of RBI. Large quantum of bad loans, weak capital levels and low return on assets have been the key culprits behind their inclusion in this club.
While RBI has been maintaining for long that PCA framework is needed to nurture weak banks to health and prevent systemic risks, of late government has been critical of RBI’s approach. PCA thus has turned out to be a contentious issue between the two and now after the change of guard at RBI, it is all set to take a relook at the PCA norms.
Is the time ripe to relax these norms in order to permit greater flow of credit or is it too early? The short answer is it may be premature to open the tap unless the weak banks have access to significant amount of capital.
What is PCA?
In a nutshell, the trigger for coming under PCA is based on performance with respect to capital position, bad assets, profitability and leverage.
There are two type of restrictions, mandatory and discretionary. Restrictions on dividend, branch expansion, Directors’ compensation, are mandatory while discretionary restrictions could include curbs on lending and deposit.
So far eleven banks namely Allahabad Bank, Bank of India, Bank of Maharashtra, Central Bank, Corporation Bank, Dena Bank, IDBI Bank, Indian Overseas Bank, Oriental Bank of Commerce, UCO Bank and United Bank of India are under PCA. Government has found an investor for IDBI Bank and a merger of Dena with Bank of Baroda and Vijaya is on the cards. The fate of the rest is still unclear.
Do they pass the CAR test?
If we look at their capital position, even after the latest round of recapitalisation, it remains close to the threshold for PCA trigger.
While RBI has pushed the deadline for reaching Capital Adequacy Ratio (CAR) of 11.5% (9% CAR plus 2.5% Capital Conservation Buffer (CCB)) to March 2020, looking at the profitability parameters of PCA banks, it doesn’t appear that these entities are in a position to comply unless significantly capitalised.
It is pertinent to note that only two out of these eleven complies with the current requirement of CAR with CCB of 10.875%.
How bad is the bad asset picture?
With gross non-performing assets of close to Rs 3.5 lakh crore, they contribute close to 1/3rd of system’s gross non-performing assets while their share in total advances is only 16%. Clearly, the underwriting expertise of these banks need an overhaul before going to the market in a meaningful manner.
None of the eleven banks are out of the PCA threshold (which is net NPA below 6%). While RBI’s February 12 Circular expedited the bad asset recognition process and to some extent the bad asset formation phase is peaking out, given the aggregate provision cover (the amount of provision held against bad assets) of 53% and tardy pace of resolution, caution is warranted.
Profitability – not yet in sight
The profitability picture is dismal too. From FY16 onwards, these banks as a group have reported a net loss every single year. While in FY16 and FY17, two out of eleven had reported profits, weighed down by bad asset recognition, in FY18 none of them reported profits. The aggregate loss in FY18 was in excess of Rs 49,000 crore and they reported a loss of Rs 9872 crore and Rs 10197 crore respectively in Q1 and Q2 of FY19.
Going by the criteria of RoA (return on assets), seven out of eleven banks had negative RoA for three consecutive years and two had negative RoA for two consecutive years.
Can they recoup lost market share without denting asset quality?
With waning system wide NPA (non performing asset) formation, in all likelihood the earnings picture would incrementally look better. But the moot question that needs to be answered is can these banks capture lost market share in the competitive market place? Lest, a relaxation at this stage will only prompt them to take exposure to lower quality credit thereby exacerbating the problem. Such lending would warrant more capital (because of higher risk weight) and could lead to resurfacing of the bad asset problem in future.
In the period between FY15 to FY18, the eleven PCA banks as a group has not shown any growth in deposits and individually only four have grown deposits in low single digit. The picture is even more dismal in advances, where some of the well capitalised private banks have been aggressively garnering market share. The group has shown de-growth in advances to the tune of 5% CAGR (compounded annual growth rate) with not a single entity showing growth. This isn’t quite a bad news for the system because if they had grown their books over this period, the size of the problem could have been even bigger warranting larger dose of capital infusion.
Does the system warrant incremental/directed lending by PCA banks?
Finally, does the system warrant incremental lending by weaker entities when the incremental credit to deposit ratio is running above 100% and credit growth is running ahead of nominal GDP?
Lending, at the end of the day, should be a commercial decision and is a sole prerogative of the individual entities, it is better left that way in the broader interest of the system.