India’s Bad Loan Problem: Why Are Banks Unable to Recover Money Owed?

Unpaid loans are only the tip of the iceberg of an ailing banking sector.

On 13 July, 2019, Allahabad Bank claimed they were defrauded by Bhushan Power & Steel (BPSL), with unpaid dues amounting to Rs 1,775 crore. Further, the Punjab National Bank (PNB) also reported fraud by BPSL amounting to Rs 3,800 crore. In 2017, the company also defaulted on nearly Rs 48,000 crore worth of loans. Moreover, Moody's, a credit–rating agency, has predicted weaker economic growth for the next 18 months, and has cautioned that this could lead to the creation of more non–performing loans.

Currently, only 12 companies are responsible for 25% of all non-performing assets (NPAs)—loans wherein the borrower ceases to pay interest instalments for over 90 days—in banks. A majority of loans that now constitute NPAs were granted in the mid 2000s, prior to the 2008 financial crisis, when company growth and performance were taken as criteria to grant loans. The 2008 crisis gave rise to the “twin balance sheet” problem, where both creditors (banks) and borrowers (corporates) are under financial duress. 

The government’s ability to recover dues owed is also under question. Vijay Mallya, owner of the now–defunct Kingfisher Airlines, defaulted in loans amounting to nearly Rs 9,000 crore, before leaving India for the United Kingdom (UK) in 2016. More recently, jewelry designer Nirav Modi, who stands accused of defrauding PNB of Rs 11,500 crore, is under arrest in the UK, and like Mallya, is fighting India’s extradition request in UK courts.

This reading list looks at instances of major loan defaulting and bank fraud in the recent past, and at policy aimed to end the NPA crisis.

1) Circumventing Fraud

K Srinivasa Rao writes that PNB being defrauded in excess of Rs. 12,000 cr stems from the bank’s inability to control operational risk. For the gems and jewelery sector, the RBI advises that letters of undertaking (LoUs) should not be issued for more than 90 days. PNB issued LoUs for a year. Rao writes that to minimise operational risk with risky creditors’ portfolios, a whistle–blower policy needs to be implemented, and staff need to be trained to spot misconduct. 

Banks tend to accord more significance to managing credit risk with which they are familiar and many tools have been developed to manage it. They are diffident in managing operational risk which could be more damaging. In every interaction with the line management, banks should discuss ways and means of curbing operational risks, particularly when banks are operating in a technology-intensive environment. Staff failure or technology failure when seen together with potential connivance of ill-willed hawks or other accomplices can shatter the reputation of banks. The only solution is to not only put operational control systems in place but also to educate every employee to improve their effectiveness as part of the operational control system. The only invincible operational risk management tool is to foster the collective collaboration of staff in the long-term interest of the industry.    

2) The IL&FS Problem

Rather than claim the presence of a “scam,” T T Ram Mohan writes that IL&FS defaulting on loan payments is rather due to banks’ reluctance to finance the infrastructure sector with long-term loans. Forced to resort to short-term loans, the company was unable to raise enough capital to repay banks within the timeframe.  

The IL&FS had a net worth of nearly ₹ 7,000 crore as on 31 March 2018. Thus, it was far from being insolvent. Its problem was illiquidity arising from the deployment of short-term funds in long-term assets. We know that, in financial firms, a problem of illiquidity can quickly turn into insolvency when confidence in a firm evaporates as lenders want their money back. Lacking liquidity, the firm tries to dispose of assets. A distress sale of assets can lead to assets being sold below book value. Insolvency soon follows. The IL&FS has precisely suffered this fate.

3) NPAs: A Failure of Neo-liberal Policy

As of March 2017, corporate borrowers accounted for 87% of NPAs. C P Chandrasekhar and Jayati Ghosh write that government attempts to have the loans repaid have failed. Debtors try to prevent liquidation, and the government does not force the issue, for fear of a backlash by the business class. In 2017–18, only two creditors recovered over 50% of total dues. The authors discuss the Financial Resolution and Deposit Insurance (FRDI) Act, 2017, which aims to create an independent FRDI Corporation to recover dues from failing financial firms. 

The tabling of the FRDI Bill is a clear declaration by the government that it sees painful resolution or liquidation as a way out of addressing the bad debt problem that currently afflicts the banking sector in particular. It also makes clear that the finance ministry, the central bank, and the government sponsored regulators will not carry any of the financial burden associated with resolution, but rather would transfer financial and other costs (such as job losses) to the employees, officers and shareholders, and even depositors holding deposits in excess of the insured amount. 

4) Repaying Debt

According to the World Bank, India takes 4.3 years to resolve insolvency, giving it a global ranking of 136 out of 189 countries. Indian creditors recover 20 cents to the dollar in this time period, compared to 80.4 cents recovered by United States (US) creditors in half the time. Rekha Mishra, Rajmal and Radheshyam Varma write that to solve the problem of NPAs, a strong regime is required. The authors suggest reforming public sector bank (PSB) management, reducing government stake in PSBs, and setting up a Bank Board Bureau to monitor government holdings in banks.  

Banks need to prioritise strengthening of their credit appraisal system, examination of the borrower’s cash flows, purpose/types and maturity structure of loans, and set a realistic repayment schedule keeping in view potential uncertainties. There is an urgent need for further deepening of the capital market as availability of alternative resources facilitates bank loan recovery. Banks need to reinvent their business models and risk management practice which are in tune with the evolving business and economic conditions. A sound resolution regime once put in place would go a long way in strengthening asset quality management efforts in a sustainable manner.

Read More:
Lessons from a ‘Scam’ | Editorial, 2018
‘Riskless Capitalism’ in India | Rohit Azad, Prasenjit Bose, Zico Dasgupta, 2017
Non-performing Assets in Indian Banks: This Time It Is Different | Rajeswari Sengupta, Harsh Vardhan, 2017

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