A study on non-performing assets in the Indian banking sector and its implications for Indian economy

Abstract

The Reserve Bank of India has been, since 2015, trying to address the growing concern of rising Non-performing assets(NPA) in the banking sector. Led by then Governor Mr. Raghuram Rajan, the RBI initiated an Asset Quality Review of the scheduled commercial banks in India. This exercise was initiated as a response to the decline in the bank results, especially Public sector Banks. A strict evaluation of the loans in the Indian banking sector revealed that the issue of NPAs was larger than as had been portrayed through the financial statements of various banks. This led to a revision in the definition of an NPA, wherein a loan whose payments were delayed by over 90 days from due date would now be considered a nonperforming asset as compared to 180 days from due date that was prevalent before. As per this definition, on March 31,2016, the Indian banking system was burdened with NPAs worth INR 322,589.9 Crores compared to INR 64,310.1 on March 31, 2005. This sudden increase in NPA can be attributed to various reasons. Prior to the financial crisis of 2008-09 India was growing at a very fast growth rate of over 7%. During this period banks, especially Public-Sector Banks, began indiscriminately distributing loans as the economy was seen booming. However, post the financial crisis many of the projects started against these loans turned uneconomical and ran into troubles, thereby making them risky assets for the banks. This was on account the following reasons : • Poor Project evaluation • Project delays • Poor Monitoring • Cost overruns • Effect of global crisis Anticipating a short-term effect of the financial crisis, the banks were allowed to restructure their stressed loans and thereby not consider then as NPAs. This, however, did not address the root cause behind banks’ underperformance. As the banks restructured these loans, the promoters found even lesser incentive to make their projects work and bring them back on track. It was then considered that it would be prudent to address these issues head on rather than delaying, which would only increase the exposure of the banks in the time to come. By writing down the NPAs, the promoter would be incentivized to bring in more equity into the projects and try getting the project back on track. Hence, the birth of the Asset Quality Review, with the aim of cleansing the Indian Banking System. The idea behind changing the classification of NPA was to get a fairer picture of the true value of the banks as should be portrayed by the balance sheet. This would lead to a temporary decline in profits for the banks in short run, but would push for sustainable growth in the future. As, the banks faced more and more stressed assets, their reluctance to roll out credit to viable projects also increased. This could be seen as the Non-Food credit growth grew only at 6.6% and Industrial credit grew only at 3.3% for Public-Sector banks. In contrast to this, private-sector banks that were more diligent in disbursing loans to viable projects, saw nonfood credit growth 20.2% and industrial credit growth at 14.6%. Hence, it was seen as necessary to clean up the system to push for higher growth in the future. The essence of the Asset Quality review is discussed next.