Asset quality review may have permanently reset banking system NPA

While NPA ratios have sharply moderated in the past two years, they are still way ahead of pre-AQR days

Just four years have gone by since asset quality review (AQR) was introduced by the Reserve Bank of India (RBI) to clean up the banking system. Yet, AQR has had a lingering impact in the system. While the exercise may go down the history as the most stringent one undertaken by a regulator in the Indian banking system to weed out toxic assets, numbers suggest that AQR may have permanently reset the non-performing asset (NPA) ratios for the banking system.

Sample this, in FY15, a year prior to the introduction of AQR, the system level gross and net NPA ratios stood at 4.3 per cent and 2.5 per cent, respectively (see chart). A year later, they climbed to 7.5 per cent and 4.4 per cent, respectively. The peak of the rigorous process was felt in FY18, when gross NPA ratio touched the 11.5 per cent mark. While the last fiscal year saw a significant easing of bad loans and rating firm Crisil expects the number to further melt to 8 per cent in FY20, experts say further easing of NPAs to pre-AQR days may not be possible anytime soon.

Though the net NPA ratio saw a sharper fall in FY19 after banks decided to hike provisions for bad loans, fresh accretion of trouble (defaults) and loan growth, which are on the mend, don’t favour a sharp improvement in NPA numbers.

“AQR came at a time when growth was anaemic for the system and hence it resulted in ballooning of NPA for banks. While loan growth has just come back, there’s new trouble brewing for banks and whether this leaves room for easing of stress is doubtful at the moment,” says an analyst with a foreign brokerage. Experts also point out that timely resolution of bad loans will play a crucial factor in easing of stress going forward. While the process so far has been quite staggering and hasn’t yielded meaty gains yet, if executed well, this could help reducing the NPA numbers going forward. There’s one comforting factor though. “IBC as a tool may result in higher recoveries than before. So, while ‘if’ and ‘when’ are the monitorable for pre-AQR levels of NPA, today’s quality of NPA is better than that in the past,” said Krishnan Sitaraman, senior director, CRISIL.

In all, AQR has certainly cleansed the system, but that has come at steep price and has completely reset the NPA levels of the system.