How the health of Indian banks has improved over the past decade
Mumbai: On Monday Prime Minister Narendra Modi said the condition of Indian banks and the wider banking sector has improved significantly over the past 10 years, during which the National Democratic Alliance (NDA) has been in power.
Domestic lenders have seen bad loans dip over the years and are much stronger than they were a few years ago, thanks to several measures taken by the government and the Reserve Bank of India (RBI).
What did the banking system look like in 2014?
Data from the RBI showed that in FY14 — the fiscal year preceding the start of the NDA government’s first term — the gross non-performing asset (NPA) ratio was at 3.8%. The bad-loan crisis peaked in FY18, when 11.2% of loans had soured.
The number denotes total bad loans as a percentage of total loans and shows the extent of toxic assets in the system. A higher number means there is a greater chance that banks’ profits will be hit unless these bad loans are recovered. It also increases the amount of money banks must set aside to cover losses from bad loans, which also dents their profits.
In its Financial Stability Report released in December 2014, the RBI said that the growth of the Indian banking sector moderated further during 2013-14, with profitability declining on higher provisions for delinquent loans and lacklustre credit growth. Credit growth was on a downward trajectory, as borne out by RBI data. Bank credit expanded by 13.6% in FY14, from 15.1% in FY13.
What steps has the RBI taken to nurse the sector back to health?
Banks have for long been accused of kicking the can down the road on stress in their balance sheets by using various debt recast schemes and through evergreening – the practice of giving fresh loans to repay existing debt – which can create a vicious cycle of increasing debt to avoid classifying a loan account as bad and having to make provisions for it. Banks are required to set aside 15-100% of the value of a bad loan as a provision, depending on how long the loan has remained unpaid.
Former RBI governor Raghuram Rajan said in a speech in February 2016 that there were two polar-opposite approaches to tackling loan stress. “One is to apply band-aids to keep the loan current, and hope that time and growth will set the project back on track. An alternative approach is to try to put the stressed project back on track rather than simply applying band-aids. This may require deep surgery,” Rajan said.
Only months before that, the regulator had conducted a deep review of banks’ asset quality, mandating lenders to uniformly classify a bad loan as such across all banks in a consortium. This led to a decline in profits but paved the way for a cleaner banking system.
Then in 2017 the RBI sent a list of 12 large defaulters to banks, asking them to refer these to the newly constituted bankruptcy tribunals under the Insolvency and Bankruptcy Code (IBC) if their stress remained unresolved. In September 2023, under current governor Shaktikanta Das, the RBI issued draft guidelines on classification of wilful defaulters, mandating lenders to identify and tag borrowers as such within six months of loans turning bad.
What steps has the government taken to clean up banks’ balance sheets?
Enacted in 2016, the Insolvency and Bankruptcy Code has helped creditors recover ₹3.21 trillion through resolution plans as of December 2023. Experts have said the IBC’s impact goes beyond resolving bad debt, and it has changed the relationship between lenders and large borrowers. After some Indian tycoons lost ownership of their businesses, many others began paying up on time to avoid that fate.
Junior finance minister Bhagwat Kisanrao Karad highlighted in July 2023 that the National Asset Reconstruction Company Ltd (NARCL) was another measure taken to reduce bad loans. “PSBs have also created stressed asset management verticals for stringent recovery, segregated pre- and post-sanction follow-up roles for clean and effective monitoring, and engaging specialised monitoring agencies for monitoring of large-value accounts,” Karad said.
How does the banking system look now?
Many experts have said the sector looks to be in its best shape in decades, with strong profitability and a low share of toxic assets in loan books. The gross NPA ratio of banks improved from 5.8% in FY22 to 3.9% in FY23, and 3.2% as of 30 September 2023, according to RBI data. Credit growth has also surged and non-food credit — bank credit after adjusting for loans given to the Food Corporation of India (FCI) — stood at 20.4% year-on-year as of 8 March.
“The health of the Indian financial system is steadily improving on the back of multiyear high earnings, low level of stressed assets, and strong capital and liquidity buffers with financial institutions,” RBI governor Shaktikanta Das said in the foreword to the latest edition of the Financial Stability Report in December.
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