Toxic loans mount: Are banks to be blamed?

The genesis of the NPA problem can be traced to the post financial crisis era when loose monetary policy was followed to prop up the economy. Low interest rates and high growth in credit helped to spur the economy which was driven by investment in sectors such as telecom, steel, mining, power, engineering etc. It was felt that India was poised to grow at an accelerated pace with the decoupling proves from the world economy setting in. At that time it was never expected that the 8% plus growth in GDP could be any other number and with a touch of hubris was assumed that there was only one way to go.

The advantage of having extra capacity in the form of lacunae in the infra sector in particular meant that there was large scope for investment. Policy makers, economists, corporates and analysts were gung ho about growth which supported over investment. Trouble started when there were a series of what can euphemistically be termed as irregularities in several sectors involving natural resources and policy. The iron ore scam, coal scam, 2G scam etc. set back progress in investment. Projects came to a standstill on account of these scams combined with what was called policy paralysis where bureaucrats did not want to take any decision.

Heavy investment in telecom through spectrum auctions delivered capacity but combined with falling prices affected the growth prospects. Power plants were started with enthusiasm, but the logjam in coal allocation meant that the companies could not produce power. Add to this the unprofitable Discoms which were not able to honour their PPAs as they were making heavy losses, the power sector went further downwards.  The steel industry was affected by non-availability of coal and iron to begin with followed by excess capacity which resulted as steel was dumped by China.  Stalled projects fed back into the engineering sector where surplus inventories resulted followed by surplus capacity. In case of several such ventures, the promoters abandoned the projects leading to a high level of stalled projects that were estimated to be in the region of '4-5 lkh crore when the NDA government took over.

The UPA and NDA governments claimed that these projects were cleared, but most of them became unviable as the backend were in disarray. This led to the creation of NPAs in these sectors. In Indian ventures typically investment is debt financed where equity is a smaller part and hence when projects are abandoned, the banks had to bear the brunt. This got reflected more in the PSB balance sheets as they were primarily financed by them while the private banks kept a distance. These numbers grew over time.

The story takes a twist when the Corporate Debt Restructuring concept came in. It was a risky concept to begin with because while a special CDR cell discussed these issues and allowed for restructuring the debt in terms of tenure and interest rate, it ended up being a case of ‘kicking the can’, wherein the problem was deferred. In fact there was a perverse incentive to reclassify and restructure these loans under this umbrella. As the scheme was supported by the government and RBI such an evergreening process was never questioned. In fact, there was strong justification for reclassification as restructured assets and it was argued that these assets failed since external conditions had deteriorated and hence different kind of treatment was required. This was probably the error made as the loans got rolled over, especially in these sectors which are today the big NPAs.

Subsequently, in end-2015, a decision was taken that there should be a fair recognition of NPAs-asset quality recognition, which transformed these restructured assets into NPAs. This was followed by the IBC with the leading cases being taken up in different batches. Hence the high NPAs witnessed especially in the infra sector are a result of all these storylines which have played out.

Can the banks be blamed for this creation of NPA stock? The answer is not clear because when money was lent, it was never expected by anyone that they would fail as they were the leading sectors. In fact the entire growth story of China was based on heavy investments in infrastructure, which led to the double digit growth rates on a sustained basis. Therefore, while the judgment was incorrect, it would be hasty to think beyond commercial calls that were made. At the margin there could have been governance issues where specific industrial groups were favoured, but almost all these NPAs were loans given to reputed companies in their fields. It was a case of project failure where the business models did not work.

Was there any cronyism involved? This could have been there in some cases, but the large numbers we are talking of in the region of 12% of outstanding credit as stressed assets cannot be linked to such cronyism.

Should they have been identified earlier? Here the answer is yes, because the concept of restructured assets was flawed to begin with which only deferred the problem without solving it. The subsequent efforts at resolving the NPA mess through different schemes were apologies at resolution.

Is the present resolution process a solution? To an extent yes, as it will keep aside these bad loans which have built up. But it could also mean that future investment could be impeded as the fear of failure of the projects can keep investment back. Further, bankers too may be unwilling to lend to these sectors and prefer the retail route.

The issue today is that it is not clear whether or not all the NPAs have been identified and whether these sectors are clean. The resolution process is in progress and the end result would be important as it will determine the future direction for these industries. They are critical components of the growth process. The reforms at the Discom level have not worked their way, which is a concern. Telecom appears to be better placed while in case of steel, the availability of bids for the NPAs is encouraging. More importantly, it is essential to know that there are no more such assets in the closet or the pain will get prolonged.

(The writer is Chief Economist, CARE Ratings. The views are personal.)