Two steps forward, one back

Overall NPA situation improves, but what of MSME lending?

The Reserve Bank of India’s (RBI’s) recently released Financial Stability Report (FSR) will have been met with some relieved sighs across the country, given that it seems to suggest that as far as the bad loans crisis in Indian banks is concerned, the worst is over. For the first time since the RBI cracked down on the “extend and pretend” approach being taken by banks to the crisis, the ratio of gross non-performing assets (NPAs) to total loans and advances has decreased, in the half year from March to September 2018. At the end of the last financial year 2017-18, in March of 2018, the gross NPA ratio was 11.5 per cent; the FSR says that at the end of the first half of 2018-19, in September 2018, the gross NPA ratio had come down to 10.8 per cent. It further predicts, using its stress test methodology, that the gross NPA ratio would reduce further by the end of the ongoing financial year, and be around 10.3 per cent by March 2019. This is no small cause for celebration. 

However, there are important caveats to be noted. For one, the situation in public sector banks (PSBs) continues to be considerably worse than in their private sector counterparts, with the gross NPA ratio at 14.8 per cent. This is a reminder that reform of PSBs cannot be ignored even if the immediate crisis appears to be passing. Indeed, this may be an opportune moment to reflect on the virtues of the RBI’s harder line on both defaulting borrowers and indulgent banks. The RBI’s “prompt corrective action” (PCA) is one such firm policy — albeit one that has come in for considerable criticism from officials in New Delhi. The government feels that the RBI has unnecessarily constrained lending from PSBs that have been forced into the PCA straitjacket. Yet the FSR contains a measured defence of the value of the PCA framework. It points out that the capital at risk from a simultaneous failure of these banks has gone down considerably — in fact, solvency losses due to such failure have more than halved over the four quarters ended September. Reducing structural risk is precisely the reason for the PCA framework and the government should not see it as the enemy. After all, it will be the government that will be on the hook if something happens to these struggling banks. 

It is in the context of this firmness on the part of the banking regulator that the recent decision to allow banks some additional time with regard to loans to micro, small and medium enterprises (MSMEs) that are stressed should be considered. This move, while ardently sought by the government, is in danger of undoing some of the good work done by the RBI with regard to big borrowers. This is one segment of the market that appears to be turning more, rather than less, stressed with the NPA ratio for public sector bank lending to MSMEs northward of 15 per cent. The RBI has moved away from “one-time” “restructuring” schemes for other loans, recognising that they tend to be neither “one-time” nor real restructuring, merely another form of extend-and-pretend. The exception made for MSMEs in the central bank’s recent notification should be rethought.