Sowmini Prasad and Deepti George
Indian banks have accumulated risks well before 2010. They had gone largely undetected by both regulators and markets until liquidity events or regulatory events such as AQR made it difficult to keep rolling over the bad debt. The Government of India and the Reserve Bank of India (RBI) have had to react with policy measures with thus far, mixed results. This tactical, reactive approach is unsustainable as it distorts credit markets, not to mention, credit blow-ups are becoming a regular feature.
Experts attribute the robustness (or the lack thereof) of banks’ risk management practices, governance quality, and the RBI’s supervisory processes as reasons for such risk build-ups. We contend that poor disclosure standards, for instance, on asset quality, is a key contributor to India’s woes. The information asymmetry not only breeds governance issues, but also allows the management, the auditors, and the regulator to look the other way till it becomes too late.
Worrisome Gap In Standards
We undertook a comprehensive benchmarking exercise of the public risk disclosure regime in Indian banking with other regimes and conventions. We found that the disclosure standards on risk position and risk management practices, including on credit risk, fall short when compared against the Basel Committee’s 1998 Framework on Enhancing Bank Transparency. Indian market participants have no visibility into basic information such as standard assets across Days Past Due (DPD) buckets, the separated risk compositions of banking and trading books by economic sector/industry and geography, or even the creditworthiness of trading book counterparties by rating categories (beyond whether they are investment grade or not/unrated/unlisted).
Investors Of A Lesser God
Next, we compared the actual asset quality disclosures made by a leading Indian bank in India for 2019-20 and 2020-21, against those made by the same Indian bank in the United States to comply with the SEC requirements for listing American Depository Shares. We found that the Indian bank was already making these disclosures for US investors, who tend to be better informed than Indian investors on three important dimensions.
One, age analysis or past due status of gross loans, retail and wholesale with further sub-classification by retail credit products by < 30, 31 to 90, > 90 DPD buckets, is unavailable in India. Indian investors must make do with disclosures on assets after they have turned non-performing. Further, distribution by loan portfolio type (retail, wholesale) is unavailable, and distribution of loans by industry is presented only for NPAs.
Two, classification of loans by credit quality indicator by year of origination; performing and non-performing retail loans with further sub-classification by retail credit products; wholesale loans as pass, labelled (with evidence of weakness), and non-performing — is unavailable in India.
Three, granular information on the top 10 credit accounts that are non-performing — such as industry type, type of banking arrangement (sole, consortium, multiple), gross and net principal outstanding, the share of the bank in collateral value, and status of interest payment servicing — are disclosed in the US, but not in India.
Arguably, had Indian investors known this information, they could have known that wholesale term loans originated before 2017 have the highest NPA ratio at 10.17 percent, and that as of March 31, 2020, commercial equipment and construction finance had the highest NPAs among various retail loan categories, at 3.1 percent, with 2.4 percent of the loans in the 31-90 DPD bucket. Further, they could have known that as of March 31, 2021, the highest share (17.6 percent) in the gross outstanding of the top 10 non-performing borrowers is that of a power sector borrower, followed by a housing finance company at 15.9 percent.
Are More Asset Quality Disclosures A Tall Ask?
Even in emerging markets, we find that Indonesia has a much higher level of risk disclosure, which shines light on any potential risk build-up. Banks there need to provide industry distribution of loans separately for those that are neither past due nor impaired (under monitoring/not under monitoring), past due but not impaired by DPD buckets (1-30/31-60/61-90) and impaired (NPA) (sub-standard/doubtful/loss).
One might ask if there is a problem that the lack of disclosures is causing. What an investor cannot see, they cannot measure, and so they cannot price and give feedback to the banks’ management. By requiring only limited public reporting on asset quality, banks in India have enjoyed a level of opacity that banks in other jurisdictions do not. This means that risk build-ups may be known to people inside each bank, but not to those outside of it, namely all capital market participants, retail depositors, and most importantly, the RBI.
So, investors are left in the lurch without information on whether banks are doing a good job of their core competency — risk management. Closing the informational gap is an essential first step that the regulator needs to take.Sowmini Prasad is Research Associate, Financial Systems Design practice, and Deepti George is Deputy Executive Director & Head of Strategy, Dvara Research. Views are personal, and do not represent the stand of this publication.