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.

RISING NPAS IN INDIAN BANKING SECTOR: CAUSES, EFFECTS, IMPLICATIONS AND REMEDIES

By Charudutt Sehgal

Introduction

The economic progress of a nation and development of its banking sector is invariably interrelated. The banking sector is an indispensable financial service sector supporting development plans through channelizing funds for productive purpose, intermediating flow of funds from surplus to deficit units and supporting financial and economic policies of the government. Banks serve social objectives through priority sector lending, mass branch networks and employment generation. Maintaining asset quality and profitability are critical for banks survival and growth. In the process of achieving such objectives, a major roadblock to banking sector is prevalence of Non-Performing Assets (NPA). In India, the problem of bad debts was not taken seriously until it was mandated by the Narasimham and Verma committee. The committee mandated the curbing of the particular issue because NPA direct towards credit risk that bank faces and its efficiency in allocating resources.

The aim of this research paper is to study the current trend of NPAs in Indian scheduled banks (up to 2013-14 only). The paper further examines the critical reasons behind the rise of this issue, its impact on Indian banking sector and Indian economy. In order to understand the criticality of the problem an effort has been made to study what impact NPAs have on ease of doing business rankings. Furthermore, the paper concludes with some of the important measures which if implemented then can improve the current scenario of NPAs in SCBs.

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EFFECTS OF DEMONETIZATION ON THE FINANCIAL SECTORs OF INDIA

By The Editorial Board of TJEF

(Anil Shankar, Gandhali Inamdar and Isha Varma)

Introduction

Demonetization has been the buzz word since November 8th 2016 when our Prime Minister made the historic announcement about the decision to discontinue the 500 and 1000 rupee notes. This historic decision has affected almost all the sectors. Some have benefited while others have suffered. This paper intends to analyze the effects of demonetization on the major financial institutions and the Indian economy in general.

Effects of Demonetization on Banking sector

Since the advent of asset quality review (AQR), there has been a rise in the number of NPAs. To get an idea, the GNPA of banks is 6 lakh crore as of June, 2016 which is 8.2% of the total loans1. These are only the NPAs as there are an equal number of restructured loans which might transform to NPAs in future.

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Figure 1: Total NPAs as of March 2016, Source: Finance Ministry

A recent data provided by the Finance ministry, which has been depicted in Figure 1, shows that 5.3 lakh crore of the 6 lakh crore NPAs are under the public sector banks. It’s clearly visible that there has been a rise in the NPAs from October 2015. This can be attributed to the ever greening of loans which led to the creation of a distorted picture of the banks. Though the asset quality review led to the identification of such NPAs which were previously classified as standard, the problem of NPAs existed since the 2008 financial crisis but remained hidden due to the above mentioned reason.

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Budget Series 2017-18-#1 Impact on Banking Sector

Akanksha Mund & Vishaka Sivanainar

The Budget 2017-18 – Banking Sector

The Union & Railway Budget released on 1st February was highly anticipated for it attempted to overcome the existing global and economic challenges. Possible increase in policy rates by the Federal Reserve, an uncertainty of commodity prices and pressure for protectionism are a few existing challenges. According to the December monetary policy statement, the Rs. 17 lakh crore demonetization of the economy slowed the growth rate down to 7.1% from the earlier estimate of 7.6%. In the past 2.5 years, the administration has become more transparent. Industry expectations included recapitalization, focus on NPAs, consolidation of government-owned banks, the creation of affordable housing, a digital push towards a cashless economy, insurance boost, reduction of the gold import duty and corporate tax rate.

Key highlights include:

NPAs – The allowable provision for NPAs has increased to 8.5%. There is a tax concession for provision on bad loans. The interest taxable on the actual receipt with respect to NPA accounts of all non-scheduled co-operative banks are to be treated at par with scheduled banks.

Cashless economy – No transaction above 3 Lakh is permitted in cash (excluding certain exceptions). After the success of the BHIM app, Aadhar Pay, a UPI for Aadhar Enabled Payment System, will be launched shortly. Banks will introduce 10 Lakh POS terminals by March 2017 and 20 Lakh Aadhar based POS by September 2017

Impressive figures – Income tax has reduced from 10% to 5% for the income slab of 2.5-5 Lakh. Rs. 10000 Crore has been allotted towards bank recapitalization compared to previous year’s Rs. 25000 crore. Government spending in the banking sector will touch Rs. 3.96 trillion in the next fiscal year. The net market borrowing figure of Rs. 3.48 Trillion (considers bought-back securities) was set.

Stock market – Banking stocks rallied more than the broader market with the BSE Bankex gaining 2.7%. Low fiscal deficits and lack of populist measures turned out to be positive for the banking stocks. Asset reconstruction companies would be allowed to list the security receipts issued against bad loans on stock exchanges registered with SEBI.

The penultimate budget in Prime Minister Narendra Modi’s tenure was remarkably neutral, however, it managed to elicit positive reactions from the banking sector.  

Development of the Indian Corporate Bond Market

By Abraham Mathew Valliyakalayil

The world GDP stood at nearly 74 trillion in 2015. The worth of the world bond markets was 100 trillion. Where was India at that time? This article attempts to juxtapose the Indian bond market with that of the world. Indian debt market is just 17% of its GDP as compared to the US which is worth 123%. We also lag behind with respect to other emerging markets such as Malaysia, Thailand, and China.

There can be a plethora of reasons for this trend. Firstly, India in contrast to these countries offers much higher interest on fixed deposits. These attractive interest rates discourage retail investment in corporate bonds as term deposits carry lesser risk. Thus, risk-averse retail investors prefer fixed deposits over debt and risk-seeking investors opt for equity. 

  Break-up of Term-Deposit & Inflation Rates of Asian Countries

Country Fixed deposit rate Headline Inflation
India 7.95 % 3.4 %
Malaysia 4.33 % 1.8 %
China 3.75 % 2.1 %
Thailand 2.8 % 1.1 %

Secondly, institutions which are the major players in the bond market shy away from investing in corporate bonds. The reason being that the secondary market is still underdeveloped, owing to the lack of demand and supply (causing market illiquidity).

Issues on the demand side:

  • The first barrier is a high SLR of 21.5% that, places restrictions on various players including banks, insurers, FPI and Provident funds. Also, only 15% of the funds is allowed to be invested in corporate bonds below AA rating. However, for mutual funds, there are no such restrictions.
  • Secondly, India lacks a well-functioning derivatives market. This hampers the ability of players to hedge credit and currency risks.
  • Lastly, a factor that banks will have to deal with is the ‘mark to market’ aspect. On the balance sheet, corporate bonds will be valued according to the market in contrast to the loans which won’t be valued similarly.

Issues on the supply side:

The institutional restrictions, preference for higher ratings (reason for higher interest rates) and the high cost of issuing (resulting in a high cost of capital, KD) has an adverse impact on number primary issues.

Conclusion: 

Analyzing the supply and demand aspects, we can say it is analogous to the chicken and egg situation. The above problems can be tackled by an effective implementation of the Insolvency and Bankruptcy Act which was passed on 5th May 2015. This can hasten the liquidation of distressed companies, thereby protecting the value of companies’ assets. It will also aid the asset reconstruction companies by attracting more participation into the NPA market. Furthermore, improved banking governance and adoption of Basel III norms mandating holding of high-quality liquid assets can also act as an elixir. Overall, these measures can improve the investors’ confidence in the corporate bond market.

Impact of The Insolvency and Bankruptcy Code,2016

By Aditya Alamuri

With the Insolvency and Bankruptcy Code 2016, Indians can finally go legally broke. The new code will step into the shoes of existing bankruptcy laws and cover individuals, companies, LLP’s, and partnership firms. The code will repair laws including those mentioned in the Companies Act, to become an overall legislation to deal with corporate insolvency. The bill now has renewed teeth to recover loans at a quicker rate.

The Bankruptcy bill has come in at a time when banks are crippled with rising NPA’s. The new code will ensure the creation of a repository of unfaltering defaulters and will result in time bound settlement of solvency.

The bill proposes the following activities to improve the banking sector:

• Creation of a database of debtors to track serial defaulters

• Usage of existing infrastructure of debt recovery and NCL tribunals, to settle individual and corporate insolvency

• Create & train a new class of insolvency professionals who will specialize in assisting sick companies

• Setting up an Insolvency and Bankruptcy Board of India, to step in as a regulator of these information utilities and professionals.

Bankruptcy code also contains provisions to deal with cross-border bungles by way of bilateral agreements with other countries. It urges shorter & aggressive intervals for every step during insolvency process.

The code also ensures that the money due to employees and workers from the 3 funds i.e. (Pension, Gratuity & Provident) is not included in the domain of either the individual or the company. Furthermore, the salaries of employees will get 1st priority up to 24 months in case of liquidation of assets of company – earlier than secured creditors.

The Bill will lead to key transformations which will ensure ease of doing business in India. Currently, as per the World Bank records, it takes more than 4 years to solve a bankruptcy case. The new code seeks to cut it down to less than a year.

The Insolvency and Bankruptcy Code 2016, on the whole, proposes a comprehensive changeover in the current Indian banking system & the way corporates function today. However, it is easier said than done. The implementation of such a vast plan will take time and we will have to wait in order to see the upshot of the same.