The Hindu : Shoring up public sector banks' health

Online edition of India's National Newspaper
Monday, Sep 15, 2003

Business

Business

Shoring up public sector banks' health

Larger borrowers commit defaults and create NPAs to the same extent as smaller borrowers.

IT IS a fact that banks extended a large number of loans to the priority sector at the behest of politicians, but their experience with these borrowers has not been unsatisfactory. The RBI had been specifically commenting on the NPA in priority sector lending, in its annual reports on trends in banking, till the year 1998.

In its report of November 15,1999, it was stated that "Sector-wise analysis of NPAs of PSBs (public sector banks) indicates that the share of NPAs of priority sector has declined from 50 per cent at end-March 1995 to 43.7 per cent at end-March 1999". And, in March 1999, priority sector lending of PSBs constituted 43.5 per cent of net bank credit.

With PSBs contributing to over 75 per cent of total scheduled commercial bank credit, the above data should be representative of the banking system. Larger borrowers commit defaults and create NPAs to the same extent as smaller borrowers. The illusion that the priority sector is less credit worthy than the bigger borrowers may arise partly due to the fact that, in lending to the priority sector, a very large number of bank officers are involved and they are aware of the problem, while in respect of larger borrowers, the malady is felt by a small segment of the banking fraternity.

Neglected area of monitoring

In the area of monitoring advances, banks in India are yet to attain high levels of professionalism, especially while extending working capital loans to industries, both small and large. Proper monitoring would require follow up of whether the advance is put to the intended use and whether the borrower is servicing the loan (paying interest, repaying principal) as per the original terms. Industries require both long term and short term funds: long term for financing fixed assets such as land, buildings and machinery and short term for working or circulating capital, that is, day to day production needs. Banks are active primarily in providing `short term' funds for working capital to industries. By the very nature of business, it is difficult to monitor physically whether the bank's loan is kept in working capital. This is because the various components of working capital are in a constant state of flux and many other sources of finance, besides bank loans, fund the working capital.

The main method to ensure proper end-use of bank funds is to examine critically the operations in bank accounts and scrutinise the financial data of borrowers at quarterly intervals. However, banks in India still seem to be obsessed with physically verifying the current assets charged to the bank at periodical intervals, usually monthly. This is done to verify whether the bank's money is invested in these assets and to fix the amount that can be lent at any point in time. This procedure was fairly useful 50 years ago, when the borrowers were engaged in traditional agro-based industries, but now it bristles with a lot of practical problems. Many bankers would acknowledge that they can achieve very little by inspecting the current assets (such as inventory and book debts) of any large industrial unit financed by them. Suffice it to say that the end use of banks' funds can be ascertained primarily by scrutiny of bank accounts and the borrower's financial statements, provided of course the borrower does not manipulate the data.

Retail loans

If technical expertise needs to be honed for monitoring industrial advances, persistence in following proper procedures is the crying need when it comes to following up retail lending in the form of house loans and consumer durable advances which seem to be the current craze among banks in India. Some decades ago, banks started lending in a big way to transport operators for buying lorries. And, they faced insurmountable problems in recovering the advances. At the same time, some hire purchase companies entered the field and had a fair amount of success in recoveries. The one main difference between banks and them was that bank officers did not take the trouble to chase the borrowers to recover, whereas the hire purchase companies did follow up vigorously. Therefore, banks need to ensure that proper and tailor-made follow up procedures are strictly observed for different forms of lending.

The interference of politicians and bureaucrats had been, it may be said without exaggeration, felt by every top banker in regard to borrowers in default. These authorities try to use their extra constitutional authority to try and wrest more funds for a troubled borrower, quite often when the latter does not deserve it. Such arm twisting is more pronounced in the larger units. Public sector banks are much more vulnerable to these pressures than private sector banks while foreign banks in India are rarely affected.

Another tip of the big NPA ice berg is the loans to public sector enterprises (PSE) owned by Central and State governments. Whenever a PSE is in financial trouble, the concerned government — Central or State — freely gives its guarantee for the advances given by banks to the PSE. But when the time comes for paying up the guarantee, on default by the PSE, the guaranteeing government rarely, if ever, pays up the amount on demand. The bureaucrats of Government always use their clout and ask the bank to write off a good portion of the guaranteed loan, and settle for a compromise.

The RBI seems to have accepted this as a fait accomplii, because it has advised banks that such guaranteed advances, when in default, should be treated as regular or performing, even though interest and/or principal repayment is in arrears. If the rules applicable to private sector borrowers are extended to PSEs whose bank loans are guaranteed by governments, the total figure of NPA of banks could increase substantially.

By all accounts, the economy was passing through recessionary conditions for some time. But then, this is not the sole or primary reason for defaults committed by some big borrowers. Mismanagement, using the company's funds for putting up white elephant projects and even draining the company's resources for personal gains are some of the reasons for failure by large industrial units. It is said freely by bankers that `there are sick industrial units, but not sick industrialists'.

Creditor friendly legislation

Lack of proper laws enabling banks to sell the security charged to them has been one cause for the NPA figure persisting at a fairly high level. The recent enactment of the securities legislation enabling banks to sell the security at short notice, without even getting the Court's permission, has considerably strengthened the hands of banks. The laws and procedures which were totally debtor friendly till recently have become fully creditor friendly. Although the new law vests almost absolute powers in the hands of banks having security, three issues will become clearer only with the passage of time.

The first is the mindset among banks, RBI, Government and the industrialists, which seems to abhor any drastic action against errant industrial units. For a long time, the country was tuned (or wedded) to a policy of `reviving' or `rehabilitating' every unit in financial trouble. Thus, a separate judicial body called the Board for Industrial and Financial Reconstruction (BIFR) was set up in the 1980s to consider cases of sick units, to see if they can be rehabilitated. The process became unduly lengthy and ultimately banks were the main sufferers, as they could not sell their security when required. The BIFR is being abolished and the new security law supercedes BIFR. Even so, the mindset of the various players will take time to change. Further, at least in bigger cases, the owners who happen to be big personalities in trade bodies they would fight fiercely any move of banks to sell the security or the company itself to others.

The second factor is whether the security charged to banks will have any value when they are sought to be sold by banks. Banks are primarily short term lenders and have been taking security of current assets, that is, stocks of materials and book debts of the borrower. These are in a constant state of flux and when the unit is in trouble, very little might be left for banks to sell; also the value would diminish in the event of forced sale.

The third factor is the extent to which the new law will help banks. It is reported that CRISIL, the rating agency, had estimated that the new law will enable banks to recover only around 12 per cent of their gross NPAs. The agency states that over 36.4 per cent of the bad loans would be outside the ambit of the new Act.

Ultimately, the new Act would help only when the advance has become NPA. A good banker should take all proactive steps to reduce the incidence of NPA and, when a few loans do become NPA, to recover them. Prevention is certainly better than cure.

To conclude, the problem of NPA has many facets. Banks are well advised to considerably tone up their systems and procedures for ensuring that their officers take reasonable precautions before granting a loan and, once a loan is granted, to monitor effectively to identify weaknesses in time.

If during the course of operations the loan shows signs of sickness, the banks should take all steps to explore various avenues of avoiding or at best reducing their losses. Banks also ought to change their mindset away from necessarily rehabilitating every sick unit and choosing this option only in rare cases, where this course of action is fully justified.

Further, the new securities Act should be utilised to deal effectively with the NPAs already in the books of banks. Verily, it is said that risk is like energy: it cannot be destroyed, but can only be transferred from one party to another. And, banks are in the business of managing risks.

(This is the second and concluding part of the article on banks' non performing assets.)

R. Viswanathan

(The author is former Deputy Managing Director, State Bank of India.)

Printer friendly page
Send this article to Friends by E-Mail

Business

News Update

Stories in this Section

Unwarranted move to change provision

Shoring up public sector banks' health

India's other outsourcing success