How to tackle Non Performing Assets in an unconventional fashion

The problem of NPAs and restructured assets has become quite exasperating with their combined level crossing the double-digit mark. We have also identified that they reside in sectors such as infrastructure, steel, textiles, aviation and mining. The RBI has been voicing concern and has warned banks to keep them under check and has said promoters cannot get away with bad loans. Do such warnings work? If the NPAs are caused by wilful defaulters, then there is a case to chastise banks for supporting them. But if it is due to conditions beyond control, which is often the way we argue these cases, then what are the options for the system?

Further, taking action against promoters is time-consuming as it can get into an elaborate legal tangle. Three slightly non-conventional ideas are discussed here to tackle NPAs. The first set of measures relates to the RBI controlling bank activity.
First, can the RBI mandate that banks should not lend to companies not repaying loans? This is not possible because one has to analyse why loans go bad and whether provision of another loan would help the cause. This is the raison d'etre for a restructuring exercise. Therefore, such a ruling will not work. Besides, lending decisions are with the bank management and can at best be placed before the Board.

Second, can the RBI actually set sectoral limits for lending? Currently, the RBI has limits on company and group lending. It is possible that the RBI can identify the top five sectors periodically - either quarterly or annually - and mandate that banks cannot go beyond a limit of say 10% of incremental credit to these sectors? This, while possible, is not advisable, as the regulator cannot come in the way of the operations of the regulated. Banks must have the freedom to operate based on their own commercial judgments.

Third, RBI can ask the boards to closely monitor lending to these vulnerable sectors and insist that banks should have an internal policy on how much lending is done to such sectors. Hence, while this will not be an RBI decision, it will be in a position to know in advance how banks are lending. This, prima facie, looks feasible as there is more transparency in operations.

The second set of issues examines ways to deepen the role of the RBI as a regulator to protect the integrity of the system and eschew a systemic problem The idea is to ensure that banks have adequate buffers for such eventualities. Here are two ideas worth exploring. The first is in the area of provisioning. With Basel III being implemented in the context of capital and RBI's own policy on dynamic provisioning for NPAs, the same can be extended to the case of vulnerable industries.
Can we think of dynamic provisioning for standardised assets in potentially weak sectors that are being supported by banks? Currently, the provisioning norms on sub-standard, doubtful and loss assets are quite firm. In case of standard assets, there is a general provisioning norm of 0.4% with higher rate for specific sectors. Here, the RBI can mandate that a current standard asset in a vulnerable sector will necessitate higher provisioning which scales up as one moves along the rank.

Therefore, if infra has the highest NPAs and mining the lowest, then the provisioning norm for mining can be 0.5% and can go up to say 2.5% for infra standard assets.

Recently, such norms were applied for forex exposures and, hence, can be extended to this area, too. Banks would necessarily have to pass on this cost to the borrower or take a hit on profits. Currently, there could be an incentive for banks to delay recognising NPAs to protect the profit line. But once such a provision is imposed on even a standard asset, banks will be left with no other choice on provisioning.

By: Madan Sabnavis
Chief Economist, CARE Ratings