Banks must not wait for growth to clean their balance sheets. Rather, growth will come once the books are cleaned, said Reserve Bank of India (RBI) governor Raghuram Rajan on Thursday. He did so while rapping the lenders for abusing the tools offered by the central bank to fight bad debt, to instead hide the extent of bad loans.
The recent clean-up operation has the central government’s blessings, he noted. Central bank officials had a series of meeting with the government, including at the “highest,” before coming up with its asset quality review (AQR) that is now causing havoc in banks’ quarterly numbers, throwing up heavy NPAs in the books, revealed the governor.
However, he made clear, this action was needed. “While growth will help the system, it would likely be significantly impaired if we did not nudge the process of clean-up,” Rajan said at the first banking summit of the Confederation of Indian Industry (CII).
Credit growth in private banks have been much more than public sector ones because the former’s balance sheets are in better shape, allowing them to fund growth, he said. “The most plausible explanation I have is that the stressed balance sheet of public sector banks (PSBs) is occupying management attention and holding them back, and the only way for them to supply the economy’s need for credit, which is essential for higher economic growth, is to clean up.”
Added rajan: “In sum, to the question of what comes first, clean up or growth, I think the answer is unambiguously, ‘Clean up!’ Indeed, this is the lesson from every other country that has faced financial stress.”
Rajan had as mentioned, scathing but veiled criticism of banks for misusing the tools RBI offered. After the 2009-09 financial crisis, it had allowed some regulatory forbearance for certain sectors. Yet, growth in those sectors remained elusive and, hence, RBI allowed banks to have tools like strategic debt restructuring, joint lenders’ forum, 5/25 loan schemes, etc. However, as in this case, a new tool can be used to deal with a problem “but also perversely, to avoid it”. “So, after giving banks the tools, RBI ended forbearance in April 2015, and then started the AQR, to ensure banks were taking pro-active steps to clean up their balance sheets.”
He cautioned, though, that not all bad debt was due to malfeasance. In fact, the greater part was of genuine NPAs and banks should help these to be nursed back to health. However, wherever there is evidence of malpractice by company promoters, “it is extremely important that the full force of the law is brought against him, even while banks make every effort to put the project, and the workers who depend on it, back on track”. The fraud detection and monitoring mechanism, as well as the new (to be enacted) bankruptcy code, would help on that, he said.
The recent plummeting in bank stocks, he noted, was not only because of global turmoil and weak equity market sentiment. RBI’s aggressive AQR and resultant throwing up of bad debt numbers was also responsible. “… part of the reason is that some bank results, mainly public sector banks, have not been, to put it mildly, pretty. Clearly, an important factor has been the AQR conducted by (us) and its aftermath.”
Rajan’s deputy, S S Mundra, earlier said at the same event that had banks engaged in early recognition of their bad debt problems, the lenders would not have thrown such a huge adverse surprise.
Under the AQR system, RBI wants to clean bank balance sheets by March 2017. And, Rajan made clear, he did not want to see a repeat of such an exercise. “The end game is clear to everyone and bounded. We do not envisage a sequence of AQRs,” he said. Applying band-aids to the loan problem and keeping it current, hoping time and growth would set projects back on track, does not work most of the time but builds more stress.
“If the bank wants to pretend that everything is all right with the loan, it can only apply band aids – for any more drastic action would require NPA classification,” Rajan said in his keynote speech. “Of course, we can postpone the day of reckoning with regulatory forbearance. But ,unless conditions in the industry improve suddenly and dramatically, the bank balance sheets present a distorted picture of health, and the eventual hole becomes bigger.”
Under the AQR, the central bank forced identification of loans that were of concern, as well as those with potential weakness. Banks are attempting to regularise those that can be put back on track and classify those that cannot for deeper surgery – and making provision on their balance sheet in accordance with the degree of extant stress. They will also make provisions for loans that have weaknesses, so that the balance sheets are cleaned and fully provisioned by March 2017.
RBI teams are working with banks to ensure they are all broadly on the same page in terms of recognition and provisioning, even if each one has flexibility on individual cases.
“This means that the December 2015 quarter results can be compared across banks to get a rough sense of the task each bank has to accomplish,” Rajan said, adding some lenders were voluntarily moving faster in recognising the problem assets. There is also no final estimate, as it is a moving target.
“It is important to recall that underlying many of these stressed loans is an economically viable productive asset, not ghost townships,” Rajan said, adding the central bank had a series of meetings with the government at even the highest levels.
“The government has been fully involved and supportive. We have mapped out a variety of scenarios on possible outcomes. The finance minister has indicated he will support PSBs with capital infusions as needed. Our estimate is that the government support that has been indicated will suffice.”
Rajan dismissed some recent NPA numbers put out by some analysts as “scare-mongering”. “In sum, while the profitability of some banks may be impaired in the short run, the system, once cleaned, will be able to support economic growth in a sustainable and profitable way,” he said.
“The market turmoil will pass,” he concluded. ”The clean-up will get done and Indian banks will be restored to health. While we should not underplay the dimensions of the task, we should be confident that it is manageable and that the government and RBI will do what it takes to make sure that banks are able to support the tremendous growth that lies ahead.”
“While growth will help the system, it would likely be significantly impaired if we did not nudge the process of clean-up
“In sum, to the question of what comes first, clean-up or growth, I think the answer is unambiguously ‘Clean up!’ Indeed, this is the lesson from every other country that has faced financial stress.”
“If the bank wants to pretend that everything is all right with the loan, it can only apply band-aids — for any more drastic action would require NPA classification”