Quick Take | MSME restructuring will trigger new wave of NPAs

Shaktikanta Das_RBI_Reserve bank of India.jpg

The Reserve Bank of India has allowed a one-time restructuring of loans to micro, small and medium industries (MSMEs). It is a retrograde step because RBI had put a stop to restructuring in a  bid to clean up bank balance sheets. It could very well trigger the new wave of non-performing assets, especially for public sector banks.

The RBI’s financial stability report (FSR) presents a number of reasons why granting a special dispensation for MSME loans is a bad idea, again, with special emphasis on state-owned banks.

For one, RBI’s analysis of TransUnion CIBIL data shows that a good portion of MSME loans outstanding has a high default risk based on the March 2018 ratings distribution.

Two, the gross non-performing assets (GNPA) ratio for state-owned banks in the MSME sector is  15.2 percent compared with 5 percent and 3.9 percent for shadow banks and private banks respectively. Clearly, state-owned banks have more lax credit standards. This is supported by additional data.

Three, state-owned banks have the highest proportion of loans in the riskiest MSME basket, according to the report. They have 17 percent of MSME loans in this basket compared to 10 percent for new private banks and 14 percent for shadow banks.

Four, the lax underwriting standards are made even clearer by the fact that in this riskiest basket, PSU banks have 62 percent share in plain or working capital loans while around 16 percent is asset-backed or retail loans. In sheer contrast, NBFCs have 80 percent of their riskiest loans in the asset-backed/retail category while new private banks have 62 percent. The report then goes on to say that, “the issue of frauds in working capital limits in PSBs in general have been highlighted in the previous FSR.”

Five, those state-owned banks under PCA restrictions showed a 166 percent increase in small (below Rs 5 crore) loans to this segment between FY 2016-17 and FY 2017-18. That’s primarily because the lending curbs kick in at much higher levels of loans.  Still, the RBI warns that this “sharp increase may require examination of possible dilution of credit standards further and additions to supervisory strategy for PCA banks.”

We all know that how the previous round of forbearance – essentially extend and pretend all is well – ended. It led to the NPA crisis which banks are still grappling with. A demand for special dispensation for the MSME sector also shows that it is under stress. A one-time restructuring just kicks that can down the road. It will lead to a reversal of the meagre asset quality gains that banks have shown.

Moreover, it will lead to other groupings and lobbies queuing up at the RBI’s and the government’s door asking for relaxations. Indeed, the power sector has been in the queue for a long time.

Yes, MSMEs have a major role to play in jobs creation and have been particularly hard hit by demonetisation and the goods and services tax. But a loan recast is not the answer. Making complex regulations simpler, cutting down the Inspector Raj and improving infrastructure are the long term solutions which the government should consider.