NPAs and Recapitalisation

By Aditya Prakash Pandey

One major challenge for Indian banks today is increasing NPAs, Collateralized Mortgage Obligations (CMOs), Collateralized Debt Obligations (CDOs), Collateralized Loan Obligations (CLOs) and other stressed assets. NPAs currently stand at 12.1% and after recognizing Rs 3.3 trillion of loans as NPAs the figure will grow above 16%. The recovery rate has now gone down from 22% in March 2013 to 10.3% as on March 31, 2016, but the NPAs are still growing. This clearly indicates that the problem of NPAs is not going to be resolved anytime soon unless some measures are taken. Another important point to note is that public sector banks cover more than 70% of the banking market and the rest is covered by private sector banks and foreign banks. With an expanding market and a larger proportion of NPAs to total assets, the public sector banks contribute for the maximum proportion of the total NPAs.

Why is ‘Solution to NPAs’ so important?

Banks earn on loans. They raise money at a lower rate and distribute them as loans at higher interest rate. The margin is what the banks earn as profits, excluding other expenses. NPAs in banks’ balance sheet limit this process.

–    NPAs lead to the lower availability of capital in hand to lend as loans and thus lower credit creation and lower banks’ profitability.

–    Having a large portion of NPAs on financials leads to loss of investor’s confidence and interest in the bank. This makes it difficult for banks to raise money from the wholesale market or capital from equity investors and further reduces bank’s loaning capacity.

This debt crunch is slowly eating into banks’ growth with rising NPAs. This scenario of continuously increasing NPAs and continuously reducing recovery rate has the potential to lead to the collapse of the banking system. Functioning of banks has been affected by growing NPAs and decreasing profitability. This can be seen from the changes in their business model. Lack of funds is leading to a lack of credit growth. So, banks have now started to get out of capital intensive brick and mortar banking model and are moving towards digital and online platforms. They are also moving out of international business to focus more on domestic market due to a scarcity of capital. On a broader perspective, it also affects the economy as it has a direct impact on the trade deficit and trade balances.

In 2016, the government allocated Rs. 25,000 crores for the recapitalisation of PSU banks. This figure has been reduced to Rs. 10,000 crores for the present fiscal year. This measure was necessary as banks needed to overcome the stressed assets and NPAs. Also, this would help the banks maintain the prescribed Capital Adequacy Ratio (CAR) as per the Basel III norms. Recapitalisation would help banks with additional capital for credit growth. But the bigger question is- Is this amount going to help in solving the problem of NPAs? If yes, to what extent?

The amount is not sufficient when compared to the size of NPAs. The reduction in the recapitalization amount has been compensated for by giving infrastructure status to affordable housing projects, as a major chunk of NPAs is stuck in such projects. The recapitalisation will help banks cover their stressed assets with the fiscal deficit target set to 3.2%. The provision for NPAs has been increased from 7.5% to 8.5%. This will reduce tax liabilities of the banks. So, in all, a balance has been maintained with the recapitalization amount and association of other measures to curb the NPA problem. But, much more needs to be done if the problem needs to be fixed once and for all.

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