The NPA denouement

Govt may have to turn some banks into narrow banks

Banking stocks have in the last few days faced pressure from worried investors after the Reserve Bank of India (RBI) surprised many banks by demanding a sharp increase in their provisioning for non-performing assets (NPAs) that have been put up for fast-track resolution under the new Insolvency and Bankruptcy Code (IBC). The RBI has reportedly asked the banks to set aside at least 50 per cent of the loan amount as likely losses for the dozen cases being settled under the IBC. It has also stipulated that if these cases are not resolved within the initial mandatory period for restructuring NPAs, then the provisioning should go up to 100 per cent. A higher provisioning eats into the profits of such banks and undermines their ability to lend further. The 12 cases in question account for almost 25 per cent of the total NPAs in the banking system and are valued at over Rs 2 lakh crore.

 
According to a CRISIL assessment, lending banks had already made provisioning for a substantial chunk of these accounts, but the new RBI order is likely to push up this number significantly. This means that banks will have to substantially increase provisioning in this financial year, much higher than what they did last year. Not surprising then, the BSE Bankex lost 1.5 per cent on Tuesday. State Bank of India (SBI) Chairperson Arundhati Bhattacharya tried to calm nerves by suggesting that the bank would be able to manage it “without much difficulty”. But SBI is the lead banker to six of these 12 accounts and it is difficult to imagine investors will buy such assurances.

 
It is true that, as the CRISIL report points out, the impact of higher provisioning can be mitigated if the banks are allowed to amortise the provisioning over six or eight quarters. But there is no doubt that higher provisioning requirements will significantly impair the capital adequacy of the banks. What makes matters worse is the government’s inability to adequately recapitalise public sector banks, which are the worst hit by the NPA crisis. Indeed, the government has asked five public sector banks to raise fresh capital from the markets in order to meet the requirements for the current financial year.

 
In sum, the way the NPA resolution seems to be unravelling, it is clear that there are few options left with the government as far as improving the health of the state-owned banks is concerned. It clearly is not in a position to fully meet their recapitalisation needs. The expectation that these banks will be able to raise any reasonable amount of capital from the market is unrealistic, especially given the low investor confidence. Mergers are riddled with several pitfalls and could possibly damage the healthier banks instead of buoying up the ailing ones. Closing down banks is politically unfeasible. That leaves just one option with the government: Turn the ailing banks into narrow banks, or banks which offer only demand deposit accounts, and back these accounts by investments in government securities only in order to avoid risks. In other words, they will cease to be proper banks, but at least the situation will not worsen.