Testing times: on the bad loans menace

Testing times: on the bad loans menace
Structural reforms alone offer a viable long-term solution to the bad loans mess
The Central government has been working hard to address India’s twin balance sheet problem, but it hasn’t had much to show in the form of results. The Financial Stability Report released by the Reserve Bank of India, for one, suggests that India is still far away from solving the troubles ailing its banks and large business corporations. According to the report released last week, gross non-performing assets (NPAs) in the banking system as a whole rose to 10.2% at the end of September, from 9.6% at the end of March. This, according to a research report released by CARE Ratings, puts India fifth among significant economies with the most NPAs. The RBI stated further that it expects NPAs to continue to rise to as high as 11.1% of total outstanding loans by September 2018, so the end to the bad loans mess seems nowhere near. The bad loans problem has also not spared private sector banks – these lenders have seen their asset quality deteriorate at a faster pace than public sector banks. Private bank NPAs increased by almost 41%, as compared to 17% in the case of public sector banks at the end of September. Non-banking financial companies that compete against banks also saw a jump in NPAs. There are, however, some signs of hope as credit growth has begun to turn the corner and shown faster growth on a year-on-year basis when compared to March.

Reforms undertaken until now though may not be good enough to tackle the problem. The resolution of bankruptcy cases, particularly against large borrowers that contribute a major share of bank NPAs, under the new Insolvency and Bankruptcy Code should help bring the NPA situation under some control. In fact, despite its many imperfections and the slow pace of resolutions by the National Company Law Tribunal, the Code can be helpful in cleaning up bank books in future credit cycles. The recapitalisation of public sector banks too can help increase the capital cushion of banks and induce them to lend more and boost economic activity. But bad debt resolution and recapitalisation are only part of the solution as they, by themselves, can do very little to rein in reckless lending that has pushed the Indian banking system to its current sorry state. Unless there are systemic reforms that address the problem of unsustainable lending, future credit cycles will continue to stress the banking system. In this regard, the government will do well to consider the recent advice of the International Monetary Fund to reduce its ownership stake in banks and give greater powers to the RBI to regulate public sector banks efficiently. Structural reforms are the only long-term solution.