S S Mundra: Asset quality challenges in India - diagnosis and prognosis
Keynote address by Mr S S Mundra, Deputy Governor of the Reserve Bank of India, at the
Edelweiss Credit Conclave, Mumbai, 28 April 2016.
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1. Shri Rashesh Shah, Chairman and CEO - Edelweiss Group; members of the
finance fraternity; delegates to the Conclave; ladies and gentlemen! It is indeed a pleasure to
be here this morning. In my address, I primarily intend to focus on some of the contemporary
issues around our banking sector that have come to dominate news rooms, court rooms,
board rooms and drawing rooms alike. I am hinting at loud vilification of bankers and
promoters without distinguishing between the victim and the black sheep. This is not an
endeavor to bat for either the banks or the promoters but only an attempt to put the things in
right perspective and to encourage an objective assessment of the situation. But before I do
that, let me begin with some good news on the economic front.
2. Amidst the continued global sluggishness, domestic growth outlook remains positive
for 2016-17 mainly on account of various structural reforms undertaken, expectations of a
normal monsoon, easing of CPI inflation and rising private consumption. Focus on rural and
social infrastructure sector and decline in subsidy outgo have resulted in improvements in the
fiscal front, both quantitatively and qualitatively. Over the recent past, steel prices have
strengthened both, globally and domestically, especially after introduction of the Minimum
Import Price. Cement and auto sectors have also shown signs of growth pick up while the
demand for oil has also increased by about 11 % in terms of quantity conveying some signs
of buoyancy in economic activity in the country.
3. Let me now come to the main issue that I wanted to focus on this morning. What I
am going to speak may sound like a medical script but that is how this story can be best
described. I begin with talking about the symptoms of the disease that had shown signs of
turning malignant.
Symptoms
4. The signs of rising stress in the banking system became increasingly evident in the
years beginning 2012. The stressed assets (GNPA+ Restd. Std. assets +Written Off
Accounts) for the banking system as a whole, which stood at 9.8% as at the end of March
2012, moved up sharply to 14.5% as at the end of December 2015. During the same period,
the stressed assets for the PSBs spiked from 11.0 % to 17.7%.
5. Similarly, the growth in net profits of SCBs was also on a declining trend since
2011-12 and turned negative in 2013-14. This decline in net profits of SCBs during this
period was primarily the result of higher provisioning on banks' delinquent loans during the
period 2012-14. This in turn impacted their return on assets (RoA) and return on equity
(RoE). The banks' spread and net interest margin (NIM) also witnessed a decline during the
period.
Diagnostic or root cause analysis
6. As in any medical exercise, the next step is to run a diagnostic check to understand
the root cause of the problems. The asset quality problems can be fundamentally ascribed to
one of the following four factors:
a) Environmental factors
The economic downturn that has engulfed the global economy since the onset of the
Financial Crisis in 2008 can be counted as one of the major cause for the asset
quality problems in India. Then, there are other external factors like fall in commodity
prices, dumping by China etc. which has led to reduced competitiveness and
consequently idle capacities and cash flow problems. The situation got aggravated
due to the policy logjam that followed in the country. Several large scale projects in
the country have remained stalled due to lack of environmental clearances,
cancellation of coal block allocation, falling through of the fuel supply arrangements,
local protests etc. Now, where do you bracket these promoters or the lending
banks? Do you brand such promoters as wilful defaulters or such lenders as
ill-motivated?
b) Corporate imprudence
The imprudence of the corporates can be attributed as the second most important
factor for poor asset quality in the system. Some of the major failings that the
corporates exhibited are:
• Overleverage - All debt, no equity; Veiled corporate structures impeded
assessment by banks
• Obsession for higher growth- Excess capacities, Unrelated diversification. The
liquidity generated due to ultra-accommodative monetary policy stance by
Central Banks in advanced economies also created misaligned incentives.
• Chasing profits eg. ignoring risks inherent in unhedged forex exposures
c) Corporate misdemeanors
Not all promoters/borrowers have had a clear conscience and some of them were out to
dupe the system by using foul means. They are willful defaulters in banks' books as they
have been unwilling to honour their payment obligations even while having a capacity to do
so. Some of the promoters have diverted borrowed funds for purposes other than for which
the finance was availed. There are also occasions where some of the borrowers have
siphoned off funds for personal gains and not created any productive asset. A section of the
promoters have also disposed off movable fixed assets or immovable property given for the
purpose of securing a term loan without the knowledge of the lender. The consequent
defaults, in such cases are intentional, deliberate and calculated and hence willful. It is this
set of promoters that need to be singled out and quickly brought to justice.
d) Banks' failings
It is not corporates alone that caused pain in the system. In several instances, the bankers
have also not exercised due caution while conducting due diligence on the projects that they
have financed. Some of the common shortcomings that the banks exhibited include:
• Governance deficit
• Poor credit appraisal particularly in infra financing such as highways where contracts
were 'gold plated'; Power which suffered from Faulty FSAs, absence of Pass
through arrangements, lack of provision for termination payments etc.;
• Weak risk management;
• Chasing quick growth;
• Pretend and Extend
7. The mistakes committed by the banks and the corporates, whether incidental or
intentional, have resulted in a massive pile up of non-performing assets in the banking
system. While the banks needed to guard against growing credit concentration risks
especially in sectors which had witnessed excessively high growth, the corporates should
have had the foresight of analyzing the emerging market dynamics. There was a general
reluctance from the banking community to admit the level of stress in their books. It was built
on the premise that NPAs are taboo and no one would be willing to lend to such accounts.
Though, this perception has some real life truth, my question is should we not administer
drug to the sick? Sometimes, there are overblown fears of unknown. If we don't address the
stressed accounts, what are our alternatives? Company position would deteriorate further, hit
banks' books and would still invite further scrutinies. Having said that, it is important to
quickly decipher whether the disease is curable or terminal and also if curable, medicinal or
surgical.
Pre-operative procedures
8. As any surgery is preceded by certain medication or other pre-operative procedure,
here also, RBI did prescribe them. It started with creation of the CRILC database which
enabled compilation of information on level of indebtedness of various groups to the financial
system. This was followed by issuance of Guidelines on "Early Recognition of Financial
Distress, Prompt Steps for Resolution and Fair Recovery for Lenders: Framework for
Revitalising Distressed Assets in the Economy by RBI, which were aimed at improving the
system's ability to deal with corporate and financial institution distress. Detailed Guidelines
on formation of Joint Lenders' Forum (JLF), Corrective Action Plan (CAP), 'Refinancing of
Project Loans', 'Sale of NPAs by Banks' and other regulatory measures were also issued to
banks for enabling prompt steps for early identification of problem cases, timely restructuring
of accounts considered to be viable and recovery or sale of unviable accounts. The 5/25
scheme and the Strategic Debt Restructuring scheme were also introduced with a view to
enable reduction in stress levels and early resolution.
Surgical procedure
9. After the pre-operative procedures, RBI undertook a surgical procedure in the form
of Asset Quality Review at banks. The exercise was aimed at tracing the sources of pain and
pressure points so that remedial procedure could be administered. GOI must be
complimented for extending total support by infusing capital /committing to infuse capital in
the weaker PSBs.
10. Whether this surgery is successful? Did it have the desired impact? I would think so.
In my interaction with various players, I sense it has a very positive impact, even in Tier II
and Tier III towns. The promoters have realized that the banks are going to come hard after
them if they don't observe credit discipline. Of course, there are skeptics who say whether it
was the right time to RBI to undertake this initiative especially at a stage when the economy
is growing slowly. Interestingly, some of these are the very same people who earlier criticized
RBI for letting things drift and banks being allowed too much of forbearance. In sum, the
larger fallout of the exercise is that there is a "better credit discipline in the country".
Unsolicited advices
11. You must have experienced how many advices come your way if you suffer from an
ailment. Every other person has an opinion and a remedy for the same, including weird
alternate therapies. Situation here is not much different. Even as RBI has launched steps to
cleanse the banking system of its ill-health, everyone seems to have become wiser about the
issue and have a prescription to offer. Some blame the patient, some blame the doctor and
still others are blaming the procedure. So called expert opinions are being voiced about the
credit appraisal process of banks, collateral availability, personal guarantee, restructuring,
staff accountability and so on. If all these prescriptions are followed, the outcome would be
akin to a successful operation, but a dead patient. In other words, the lending process would
freeze.
Post-operative care
12. All post-operative cases require rehabilitation and so would the banking system.
There is a need for the system to pause and reflect on what has gone wrong. The form of life
style change for the banks would be to concentrate on credit risks that they understand and
which fall well within their risk appetite. Going forward, they have to refrain from binging on
what their neighbors are eating. More simply put, the Board and the Top Management have
to steer the bank in a manner that they have a robust credit appraisal process, effective
postdisbursement supervision system, a diversified portfolio and better risk governance. The
lifestyle changes for the borrowers on the other hand would entail adoption of a regimen
more attuned to a marathon runner than a sprinter. Running enterprises is not a one-off
sprint. Like a marathoner, one has to be conscious of the external environment at all times
and run at a steady pace without exhausting himself.
Remedial measures
13. Even post AQR, challenges abound. What are the possible solutions? That a vast
majority of the corporates are overleveraged with severely diminished debt servicing ability is
common knowledge. There are projects which need fresh capital, new management and new
promoters. Banks are wary of increasing their commitments to accounts which are in stress,
for a variety of reasons. It may be extremely difficult to operate the enterprise profitably
without paring down debt levels and hence, a first step could possibly be to bring down the
debt to a manageable level. This might involve writing down a part of the debt by the lenders
and/or converting them into equity and bring in a new promoter to run the enterprise. This
might, however, be a time consuming process and hence, in the interim the banks may need
to appoint an O & M agent to run the operations.
14. In certain cases, there may be a need for additional funding for some residual
investment or for working capital needs. A major impediment observed in JLF functioning is
slow evolution of consensus among the consortium members and hence, the resultant action
plan gets delayed invariably. The delay somehow defeats the very purpose for which the JLF
mechanism is set up. There are some views about setting up an investment fund which might
come in as a last mile lender. The investment fund could lend to the truncated enterprise and
help it get back to profitability at which level banks could profitably dilute their equity holdings
in the firm. Question is who would fund this investment fund? My sense is it would have to be
joint endeavor of multiple players in this arena. Moreover, extending financial support would
not be sufficient. Such fund would also need to have capability to provide management
bandwidth to the concerned projects.
Conclusion
15. Let me conclude by saying that the global economy has been passing through a
difficult phase and vulnerabilities remain. Against this backdrop and that in a globally
integrated economy, a general decline in the asset quality was not totally unexpected.
However, the extent being witnessed could have been avoided. It is probably because
neither the banks nor the corporates resorted to preventive healthcare. I am sure that
everyone would emerge much wiser after enduring the pain and be circumspect in the
approach and get a periodic checkup done so that they can stay healthy and live longer.
16. For the enterprises under temporary duress, we must stretch every sinew to ensure
that a productive enterprise does not become terminally ill. There are suppliers- sometimes
in the form of small ancillary units or MSMEs and then, there are workers and their families.
Each enterprise supports many lives. There is an entire ecosystem around a factory or
company. Closure of any running unit would impact the lives of scores of people and hence, I
feel it's a collective societal responsibility that productive enterprises don't run aground.
I thank Edelweiss Management for inviting me to this Credit Conclave today and wish the
deliberations all success.
Thank you!