Banks' non-performing assets: Where have all the risk managers gone?

When we now talk about stressed loans of more than Rs 10 trillion, the 10 years from 2004 to 2014 become important, for this was the period when these loans were sanctioned and disbursed

The government decision between 2004 and 2009 to award captive coal mines for power projects unleashed the Indian corporate entities’ animal spirit. And, the demand for long-term project loans zoomed.

When bankers and analysts now talk about stressed loans of more than Rs 10 trillion, the 10 years from 2004 to 2014 become important. For, this is the period when these loans were sanctioned and disbursed. The period after the global credit crisis of 2008 is of particular importance.

According to a February 2017 speech by RBI Deputy Governor Viral Acharya, stressed assets accumulated because of “excessive bank lending, en masse, in a relatively short period from 2009 to 2012,” and to a concentrated set of large firms in a number of sectors, such as infrastructure, power, telecom, metals (iron and steel, in particular), and engineering-procurement.

By the end of 2012, the Comptroller and Auditor General of India (CAG) found irregularities in the coal mine allocation process. Following an investigation by the Central Bureau of Investigation (CBI), the Supreme Court in September 2014 quashed the allocation of 214 coal blocks, extending back to 1993.

By 2013-14, the newly started projects closed down and NPAs in the power sector became a nightmare for banks. The demand for iron and steel and other commodities collapsed globally and Indian firms were in a crisis. Fast-forward to now: Most of these companies are also bankrupt.

The gross non-performing advances ratio of banks increased to 9.1 per cent in September 2016 from 7.8 per cent in March, pushing the overall stressed advances ratio to 12.3 per cent from 11.5 per cent. The large borrowers registered significant deterioration in their asset quality, said RBI’s financial stability report. Half of the 12 stressed accounts referred by the RBI for immediate bankruptcy proceedings in July was from the steel sector in particular. Most of the loans were given by public-sector banks.

“It would be safe to assume that had proper risk pricing been done, many of the current NPAs could have been properly assessed very well in advance," said RBI Deputy Governor N S Vishwanathan on Thursday.

His remarks came a few days after his colleague Viral Acharya criticised banks for not having better interest rate management capabilities. But should the bankers be blamed alone?

“Yes, it is true that Indian banks lack risk-pricing ability. There are historical reasons why banks lack that skill, but our regulatory guidelines are partly to be blamed,” said K C Chakrabarty, former RBI deputy governor.

For example, in case of bond investments, the standard practice globally is that at the very instance when bonds are bought, the bank has to earmark it as Held to Maturity (HTM), or Available for Sale (AFS). But in India, year after year, RBI has allowed banks to move their bond holding from AFS to HTM. Naturally, the risk-management system doesn't flourish in such an environment. And then there have been subvention schemes for specialised small loans.

“What started with smaller loans has now extended to larger, corporate loans. That is now biting banks,” said Chakrabarty.

Seasoned bankers say there had been immense competition and a real risk that well-rated customers could shift to other banks for half a percentage point arbitrage in loan offer. In a growth phase, banks couldn't afford to let clients go. RBI did not help much, either.

“When coal mines were de-allocated, everything fell through. RBI did not allow the extension of loan tenure, they put up steep provisioning on restructuring and, often, the provisions were uneven across banks for the same set of accounts,” said Pratip Chaudhuri, former chairman of State Bank of India.

Chaudhuri also said the Reserve Bank frequently criticised banks without really coming up with a solution. “Why can’t RBI give banks models to manage various risks? Let them come up with a pricing formula,” Chaudhuri said.

Indian banks’ lack of ability to price loan correctly goes back to the 1970s, when the Differential Rate of Interest (DRI) scheme was introduced to give heavy subsidies to critical sectors, at the behest of the government. Over time, this became the culture of public-sector banks, said K C Chakrabarty.

“The bigger the loan, the higher would be the transaction cost, and the pricier it should be to get. But, paradoxically, big-ticket loans are cheaper in India. And, often, a firm rated lower gets the big loan at a cheaper rate than a better-rated one’s small loan,” Chakrabarty added.

There is no denying that public-sector banks lent irresponsibly to certain sectors and there was a herd mentality in doing so. But everyone bet on the economy, and bankers were not alone in this.

“It is wrong to assume that at public-sector banks there are no effective risk-management strategies. In fact, we regularly engage in these practices. But we also take huge bets, and what appears good in good times might seem bad when the environment turns adverse,” said a senior public-sector banker who did not wish to be named.

Meanwhile, the government flip-flopped on its policies. Banks gave loans based on solid collateral and depending upon government backing of captive coal mines, supportive policies on iron and steel and other infrastructure projects in the first place.

Bankers also say that the RBI turned impatient and forced banks to recognise losses at the risk of destabilising the organisation, while the guidelines on restructuring, etc, were too complex and most of them failed.

Because of the frequent transfers in job roles, the chances of specialising in a function is less at a public-sector bank. The banks tried to address that talent shortage by some lateral entry in roles such as those in the technology verticals, but top management could not bring outside talent in treasury and risk management, though banks lobbied hard with the government for that.

One of the primary reasons was the inability to give market salaries for these positions.

Incidentally, public-sector banks are still used for influencing the currency and bond markets, something that the regulator cannot deny when it criticises banks’ interest rate management skills. This, then, prevents an effective risk-management culture to take root at India's government-owned banks.

• When analysts now talk about stressed loans of more than Rs 10 trillion, the 10 years from 2004 to 2014 become important

• This was the period when these loans were sanctioned and disbursed

• RBI Deputy Governor Viral Acharya said stressed assets accumulated because of “excessive bank lending, en masse, in a relatively short period from 2009 to 2012”

• By the end of 2012, the CAG found irregularities in the coal mine allocation process. 

• Following a CBI probe, the Supreme Court in September 2014 quashed the allocation of 214 coal blocks, extending back to 1993

• By 2013-14, the newly started projects closed down and NPAs in the power sector became a nightmare for banks