nanwani & yogesh mase 287-317(1).pdf · 2020. 3. 27. · title: nanwani & yogesh mase.p65 author:...

Prajnan, Vol. XLVIII, No. 4, 2019-20 © 2019-20, NIBM, Pune

Received: 23/10/2019

Accepted: 14/01/2020

Stressed Assets in Indian ScheduledCommercial Banks

B H NanwaniYogesh D Mase

The study presents a comparative statistical analysis of Stressed Assets(SAs) in Indian Scheduled Commercial Banks including Public, Privateand Foreign Banks. Stressed Assets (SAs) is among the few bestindicators of the health and performance of the banking industry andprimary indicators of credit risk. The findings throw light on themagnitude of the stressed assets problem with various reason andindicate need for concerted efforts to control the same.

Keywords: Gross NPA, Stress Asset Management, Bank Performance

JEL Classification: E30, E44, G21

Section IIntroduction

Banks play a vital role in the development of sound economy, given that theyprovide financial resources to capital intensive as well as high growth sectors.In emerging economies like India, banks have an additional responsibility ofachieving government's social agenda as well. Hence the performance of theoverall economy is closely tied with performance of the banks.

A major threat to Indian Banking sector is prevalence of a huge amount ofStressed Assets (SAs) which includes Non-Performing Assets (NPAs) and Re-Structured Assets (RAs). A high level of NPAs suggests strong probability of alarge number of credit defaults that adversely affects the profitability and net-worth of banks and erodes the value of the assets.

Restructured assets or loans are assets which have been granted extendedrepayment periods and /or reduced interest rates, conversion of part loan intoequity and provision of additional financing. Restructured assets are thuspast NPAs or those that have been modified or restructured into new loans.

B H Nanwani ([email protected], [email protected]), Director, Sadhu Vaswani Instituteof Management Studies for Girls, Pune, Maharashtra.

Yogesh Mase ([email protected]), Ph.D Student, Savitribai Phule Pune University, Pune,Maharashtra.

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ObjectivesThe objective of the paper are to undertake comparative trend analysis ofStressed, Restructured and Non-Performing Assets of public, private and foreignbanks during the financial years (2006-07 to 2017-18). Further to establishlikely reasons for the occurrence of NPAs, and study recent measures to controlthem.

ScopeThe study is restricted to a comparative analysis of Stressed Assets in theperiod from fiscal year 2006 -07 to 2017- 2018 in public, private and foreignbanks (Scheduled Commercial Banks listed in the Second Schedule of the RBIAct, 1934).

To understand causes responsible for rising Stressed Assets in Indian bankingsystem, during three separate periods i.e. Pre- Global Financial Crisis (2006-08), during Global Financial Crisis (2008-09) and Post Global Financial Crisis(onwards 2009-10).

Sources of DataThe Research paper is built on secondary data sourced from literaturepublished by Indian Banks, Financial Stability Report by Reserve Bank of India,various magazines, journals, books dealing with the banking and other researchpapers

Section IILiterature Review

Narasimhan Committee set up by RBI in 1991 and others (Ramu N, 2009,Bhatia, 2007) established the importance of NPAs in determining theprofitability of banks. The Committee identified NPA as a major threat andrecommended prudential measures for income recognition, asset classificationand provisioning requirements. Issue of NPA and its impact on erosion of profitand quality of asset was not seriously considered in Indian banking prior to1991. NPAs are considered as an important parameter to judge the performanceand financial health of banks. The level of NPAs is one of the drivers of financialstability and growth of the banking sector.

Gopalakrishnan (2005), Kaur (2006) classified the causes for NPAs intopolitical, economic, social and technological areas and observed that neglectof proper credit appraisal, lack of follow-up and supervision, recessionalpressures in economy, change in government policies, infrastructuralbottlenecks, and diversion of funds are the major causes of NPAs. This iscoupled with recessionary trend and failure to tap funds in the capital anddebt markets, business failure (product, marketing, etc.), inefficient

Nanwani & Mase: Stressed Assets in Indian Scheduled Commercial Banks 289

management, strained labour relations, inappropriate technology/technicalproblems, product obsolescence, recession input/power shortage, priceescalation, accidents, natural calamities, etc.

Pandey and Kaur (2012) observed other causes of NPAs including the willfuldefault i.e. non-payment of dues despite having adequate cash flows and networth, signs of siphoning the funds by the borrower, falsification of records,disposal of securities without bank's approval, fraudulent practices, etc.

Selvarajan & Vadivalagan (2013), Nagaraj, Sathyanarayan & Ali (2014)examined significant relation between both priority and non-priority sectorNPAs in contributing to the total NPAs in public sector banks. Goyal, Agrawaland Agrawal (2015) concluded that priority sector lending is a major contributorto NPAs in public and private sector banks.

Siraj K K and P Sudarsanan (2012) mention that the accounting treatmentalso failed to project the problem of NPA, as interest on loan accounts wereaccounted on accrual basis. Parul Khanna (2012) analyzed the RBI report onTrend and Progress of Banking Sector, concluded that reduction of NPAs inbanking sector should be treated as a national priority issue to make the IndianBanking system stronger, resilient and geared to meet the challenges ofglobalization.

Ms Arundhati Bhattacharya (2016) SBI Chairperson, express her concernsabout increase in NPAs in public sector banks at Associated Chambers ofCommerce and Industry of India (ASSOCHAM). She further mentioned thatbank's non-performing assets were owing not just to stakeholders, such aspromoters, government, lenders but even regulators are to be blamed for policyuncertainty as well.

Dr Raghuram Rajan (2016), former Governor of RBI has mention in his speechon "Issues in Banking Today" at the Confederation of Indian Industry (CII) firstbanking summit, at Mumbai. He addressed issues of Dealing with Stressedloans, Banks Asset Quality Review (AQR), Improving Bank Management andGovernance, etc. Further added that the Reserve Bank set about giving banksthe tools to deal with stressed loans, including information about the degreeof the borrower's collective indebtedness from the system and more effectiveways to reduce the project's financial stress such as the Joint Lender's Forum,the Strategic Debt Restructuring mechanism, the 5/25 mechanism and recentsteps on Asset Quality Review to ensure that banks were taking proactive stepsto clean up their balance sheets on NPA's.

After studying all these research papers, some major points are concludedlike NPA is major threat to profitability of both public and private sector banks.However, most of the research papers are focusing on NPAs causes, effects andnot on Stressed assets in banking sector which includes Restructured Assets

290 Prajnan

as well. Therefore, this research paper evaluates the Stressed Assets includingNon-Performing Assets and Restructured Assets in Indian Banking sector.

Section IIIConcept of Performing Assets, Non-Performing Assets,

Restructured Assets and Stressed Assets

Performing Asset (PAs)A loan asset generates the income expected from it and does not disclose anyunusual risk other than normal commercial risk, it is treated as performingasset,

Non-Performing Asset (NPAs)A loan asset becomes a Non-Performing Asset when it ceases to generate income,i.e. interest, fees, commission or any other dues for the bank for more than 90days.

Restructured Asset (RAs)Restructured Assets are NPAs that are modified as new loans based on theviability of the corporate borrower. Such loans may have been given one or acombination of facilities like extended repayment period, reduced interest rate,converting a part of the loan into equity, providing additional financing, orsome such combination of measures.

Stressed Assets (SAs)Stressed assets (SAs) are simply a total of Gross Non-Performing Assets (GNPAs)and Restructured Assets.

Stressed Assets are getting increased attention as the trend of deterioratingasset quality has emerged as a big economic risk for the Indian Banking sector.NPAs alone do not tell the whole story of the bad asset quality of loans given bybanks. Therefore, it is important to understand the magnitude of Gross Non-performing Assets and Restructured Assets or Stressed Assets.

Impact of Stressed Assets on bank operationsStressed assets affect current profitability as well future stream of profits,reduces the earning capacity of assets and adversely affects the Return onInvestments. Higher provisioning requirement on mounting NPAs adverselyimpacts capital adequacy ratio affecting liquidity. NPA upsets calculations ofEconomic Value Additions (EVA) which equals to net operating profit less costof capital. Cost and Time including efforts of management which banks haveto bear for recovery of NPAs. Most important, loss of brand image and goodwill


has a negative impact on investors and depositors. NPAs brings fall in thevalue of shares

Table 1Stressed Assets in Indian Banks from 2006-07 to 2017-18

(in Per cent)

Period Year All PSB PB FB

Pre GFC2006-07 3.1 3.3 2.5 2.5

2007-08 3.0 3.1 3.2 2.5

GFC 2008-09 5.0 5.0 5.1 4.5

Post GFC2009-10 6.9 7.2 5.2 4.8

2010-11 6.1 6.9 3.8 2.9

2011-12 7.7 9.1 3.8 3.0

Indian 2012-13 9.2 11.0 3.8 3.1

Banking 2013-14 9.9 11.9 4.0 4.0

Sector 2014-15 11.1 13.2 4.6 3.3

Under 2015-16 11.5 14.5 4.5 4.5

Stress 2016-17 12.0 15.0 4.7 4.3

2017-18 12.5 16.7 5.1 3.9

Graph 1Stressed Assets in Indian Banks from 2006-07 to 2017-18

Source of Data and Graph: Calculations by the authors based on secondary data available on

https://rbi.org.in and https://dbie.rbi.org.inStressed Assets = Gross NPA + Restructured Assets, PSB = Public Sector Banks, PB = PrivateSector Banks, FB = Foreign BanksPre GFC: Two years before Global Financial Crisis, GFC: Period of Global Financial Crisis,Post GFC: Two year after Global Financial Crisis

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Observations for Table 1 and Graph 1Till 2008-09 (up to GFC period), public, private and foreign banks were havingalmost equal share in Stressed Assets. After 2009-10 (Post GFC), majorcontribution from public sector banks for increase in Stressed Assets. StressedAssets in Indian banking sector increases four times over a decade (3.1 percent in 2006-07 to 12.5 per cent in 2017-18). Public sector bank stressedassets have increased over five times from 3.3 per cent to 16.7 per cent whileprivate sector banks have registered growth from 2.5 per cent to 5.1 per centover a decade. Foreign banks have highest stressed assets during andimmediately after Global Financial Crisis (GFC) peaking at 4.8 per cent in2009-10. Indian Banking sector crippled under Stressed assets since2011-12, three years after GFC period (2008-09.

Causes responsible for rising Stressed AssetsIndian banking system protected from Global Financial crisis due to variousreasons. Major reasons are, Indian banks must to maintain assets in Indiaamounting to 40 per cent of their total liabilities in India in addition to CashReserves. Banks were not permitted to borrow outside of the country for lendingpurposes. Permissible limit of foreign borrowing for capital was linked to theirCapital to Risk-Weighted Assets Ratio (CRAR). Indian banks have less exposureto sophisticated investment products and subprime mortgages that were atthe root cause of GFC. According to economist, Kaushik Basu, along withprecautionary norms of the Reserve Bank of India (RBI), the pervasive use of'black money' in the economy created a shield against the crisis in the bankingsector. To avoid taxes, a large part of the payment in almost all propertypurchases in India is made in cash which makes the declared value of propertylower than the actual value. Mortgage loans can only be raised on the declaredvalue, therefore, even when prices fell in 2008-09 (GFC period), bank loanswere well within the value of property in India.

The real economy, on the other hand, was connected with the global economyand the impact on the banking sector came largely through this channel.Financial sector collapse in the US had spread to real sector via a credit crunchand resultant lowering of aggregate demand, causing a recession. However, itis important to note that Global recession began at the end of 2008, but India'sslide into industrial stagnation and insolvency began three years later in 2011.

The major reasons for three years delay sliding into industrial stagnation evenafter successful sail through Global Financial Crisis (GFC) are:

Infusion of Foreign Capital in India

With global financial crises in developing economies in 2008-09 (GFC Period),capital infusion continued in emerging economies – including India – whereinterest rates were higher. To stimulate aggregate demand and revive growth


after GFC (2009-10 onwards), US and other advanced economies adoptedexpansionary monetary policies, lowering interest rates to near-zero levels,less attractive of FI to invest further. Developing economies like India benefitedduring this period.

Strong Performance of Stock Market

The sharp increase in FIIs in the years following the GFC (2009-10 onwards)largely drove the strong performance of the stock market. Immediately afterthe GFC, the stock market did crash. However, given the low participation inequity investment among Indian households, the stock market did not haveany significant wealth and consumption effects.

Robust Economic Growth

GDP growth was maintained in India throughout 2009-11 (after GFC) due tostrong domestic demand during this period. In the pre-GFC period (2006-08),India was growing faster than global emerging Market Economies (EMEs) andadvanced economies, however, Post-GFC, growth fell most sharply in India –from 9.8 per cent in 2007 to 3.9 per cent in 2008. In advanced economies,which were the most affected by GFC, the rate fell from 2.7 per cent to 0.1 percent; the corresponding fall in other emerging market economies (EMEs) was8.5 per cent to 5.7 per cent. In 2009, while growth in India jumped up to 8.5per cent, it continued to fall in advanced economies (to -3.4 per cent), andother EMEs (to 2.8 per cent).

Surge in Foreign Exchange Reserves in India

On the back of strong inflows, the RBI accumulated reserves at an acceleratedpace between 2006-08 (Pre GFC), which helped India deal with theconsequences of the GFC. India's foreign reserves rose sharply driven byportfolio inflows, investment flows and a narrower current account deficit.Between April 2007 and February 2008 from $200 billion to $300 billion andstayed between $300 billion and $400 billion for more than nine years, beforetouching the $400 billion in September 2018.

Policy Response to GFC and Fiscal Deficit Control

In line with efforts made by governments and central banks all over the world,the Indian government and RBI took active steps to counter the slowdown,significantly relaxing monetary policy (interest rate reduction) and introducingfiscal stimulus to boost domestic demand. The round of stimulus helped spureconomic growth.

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Above all measures supported the belief that Indian economy will sail throughGlobal Financial Crises (GFC) successfully. However, after 2011 Indian economyslide into recession with industrial stagnation.

Stressed Assets since 2011-12 despite Indian Economy successfully sailingthrough GFC period 2009-11In order to arrest the financial problems in banks at an early stage, a structuredearly intervention system called Prompt Corrective Action (PCA) system wasintroduced in India by RBI on December 21, 2002. The fundamental premisebehind the PCA framework based on the 'to act before it's too late' principle.

A set of banking performance criteria on three parameters were used todetermine the severity of a bank's stress. Accordingly, restrictions were placedon its management and activities to arrest financial problems in banks underPrompt Corrective Action framework. This banking performance criteriaincludeed:

(a) CRAR (Capital to Risk-Weighted Assets Ratio): (i) less than 9 per cent, butequal or more than 6 per cent, (ii) less than 6 per cent, but equal or morethan 3 per cent, (iii) less than 3 per cent.

(b) Net Non-Performing Assets (NPAs) to net advances ratio for evaluation of assetquality: (i) over 10 per cent but less than 15 per cent, (ii) at 15 per cent andabove.

(c) Return on Assets (ROA), profitability measured as net profit to total assets:(i) below 0.25 per cent.

As far as overall performance of banks on these counts was concerned, itimproved over the years and compared favourably against those in the developedand other emerging economies, even during period of GFC. Against thisperformance parameters, the CRAR rose up from 10.05 per cent in 1997 to12.28 per cent in 2005, profitability measured in terms of ROA increased from0.67 per cent in 1997 to 0.91 per cent in 2005, and the asset quality improvedin terms of decline in 'net NPA to net advances ratio' from 8.1 per cent in 1997to 2 per cent in 2005. The improved performance continued even in the yearIndian banks were hit by the effects of Global Financial Crisis (GFC) in 2008-09. In 2008, CRAR improved to 13 per cent, ROA rose to 1.12 per cent and netNPA ratio came down to 1 per cent with trend continued. Till March 2015,CRAR, Net NPAs and ROA was never reached below threshold limit for ScheduleCommercial Banks including public sector bank. First time in March 2016 allpublic-sector banks reported a negative 0.2 per cent Return on Assets, muchbelow threshold limit set by PCA system.


Table 2Trend of Capital to Risk-Weighted Asset Ratio (CRAR),

Return on Assets (ROA) and Net NPA(in per cent)

All Banks Public Sector Banks Private Banks Foreign Bank

Period Year CRAR ROA Net CRAR ROA Net CRAR ROA Net CRAR ROA NetNPA NPA NPA NPA

Pre GFC 2006-07 12.28 1.05 1.01 12.36 0.92 1.05 12.10 1.02 0.97 12.39 2.28 0.73

2007-08 13.01 1.12 1.00 12.51 1.00 0.99 14.34 1.13 1.09 13.08 2.09 0.77

GFC 2008-09 13.97 1.13 1.05 13.49 1.03 0.94 15.23 1.13 1.29 14.19 1.99 1.81

Post GFC 2009-10 14.54 1.05 1.11 13.27 0.97 1.09 17.43 1.28 1.03 17.26 1.26 1.82

2010-11 14.19 1.10 0.97 13.08 0.96 1.09 16.46 1.43 0.54 16.97 1.75 0.61

Indian 2011-12 14.24 1.08 1.29 13.23 0.88 1.53 16.21 1.53 0.46 16.75 1.76 0.61

Banking 2012-13 13.88 1.03 1.68 12.38 0.78 2.01 16.84 1.63 0.52 17.88 1.94 1.01

Sector 2013-14 13.00 0.81 2.12 11.30 0.50 2.56 16.80 1.65 0.66 17.75 1.54 1.09

under 2014-15 13.10 0.81 2.38 11.60 0.46 2.93 15.75 1.68 0.89 17.40 1.84 0.54

Stress 2015-16 13.20 0.31 4.60 12.30 -0.20 6.10 15.60 1.50 1.32 17.20 1.45 0.81

2016-17 13.60 0.40 5.50 12.20 -0.47 7.90 15.40 1.40 1.80 18.10 1.30 0.40

2017-18 13.80 -0.20 6.10 11.70 -1.00 8.60 16.40 1.20 2.00 19.10 1.20 0.40

Source: Secondary details separately available for CRAR, ROA and Net NPA on https://rbi.org.in

Observations for Table 2Evaluating against above set performance criteria by PCA, overall performanceof all banks continued to improve till 2012-13 before showing sign of downwardtrend from 2013-14. CRAR continued to rise up from 10.05 per cent in 1997to 12.28 per cent in 2006-07 and at 13.8 per cent in 2017-18 for all banks.ROA increased from 0.67 per cent in 1997 to 1.05 per cent in 2006-07 andremained above 1 per cent up to 2012-13 in all banks. ROA was never below0.25 per cent in public sector banks till 2015-16 and for overall banking sectortill 2017-18. Net NPA to net advances ratio improved from 8.1 per cent in1997 to 1.03 per cent in 2012-13; it never crossed 10 per cent Net NPAperformance criteria as mention in PCA framework till now, with highest ratioof 6.1 per cent recognized in 2017-18.

This clearly shows that Performance Criteria parameters under PCA frameworkfailed to reflect Stressed assets in Indian Banking sector till public sector banksshowed negative 0.2 per cent ROA in 2015-16. However, Indian banking sectorbanks were crippled by Stressed assets since 2011-12. Therefore, CRAR, ROAand net NPA to net advances performance criteria did not tell the whole storyof bad assets quality loans given by banks.

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It is important to note that over the years if these assets were under stress andon the Indian banking sector balance sheets, it was not reflected immediatelyunder PCA framework after Global Financial Crisis (GFC) in 2008 and evenup to 2015-16 when first sign were shown by public sector banks with negativeROA. As per theory, Stressed assets soar when there is an economic crisisresulting in bankruptcies in industrial sector. The present crisis in bankingsector and the global recession of 2009, like the previous three global recessionsof 1975, 1982 and 1991 and the great depression of the 1930s, led all banksto compulsorily restructure a large number of their debt.

This is exactly happened in India, post-global Finance Crisis with soar inRestructuring Assets (RAs) in Banking Sector in 2008-09 and continued toincrease till 2014-15. Increase in Restructuring of Assets were prominentlyseen in public sector and private banks (Table 3). Therefore, Stressed assetsin Indian Banking sector started accumulating in restructuring assets since2008-09 during GFC period and continued till 2014-15 even though the Indianeconomy successfully sailed through GFC.

The below data gives the answer providing comparative data of GNPA,Restructured Assets (RAs) and Total Stressed Assets in Indian Banking Sectorfrom 2006-07 to 2017-18.

Table 3Trend of GNPA, per cent Restructured Assets and

Stressed Assets in Schedule Commercial Bank

Gross NPA Net NPA Restrurctured Stressed Assets Restuctured Assets(A) (B) Assets (C) (D=A+C) to Stressed Assets

Period Year All PSB PB FB All PSB PB FB All PSB PB FB All PSB PB FB All PSB PB FB

Pre GFC 2006-07 2.5 2.7 2.2 1.8 1.0 1.1 1.0 0.7 0.6 0.7 0.3 0.7 3.1 3.3 2.5 2.5 18.0 20.4 10.2 28.3

2007-08 2.2 2.2 2.5 1.8 1.0 1.0 1.1 0.8 0.8 0.9 0.8 0.7 3.0 3.1 3.2 2.5 26.3 28.4 23.3 28.5

GFC 2008-09 2.2 2.0 2.9 3.8 1.1 0.9 1.3 1.8 2.7 3.0 2.2 0.7 5.0 5.0 5.1 4.5 54.8 60.6 43.1 16.1

Post GFC 2009-10 2.4 2.2 2.7 4.3 1.1 1.1 1.0 1.8 4.5 5.0 2.5 0.5 6.9 7.2 5.2 4.8 65.4 69.6 47.3 11.2

2010-11 2.4 2.4 2.5 2.5 1.0 1.1 0.5 0.6 3.7 4.5 1.3 0.4 6.1 6.9 3.8 2.9 60.0 64.9 35.0 13.5

Indian 2011-12 3.1 3.3 2.1 2.8 1.3 1.5 0.5 0.6 4.6 5.8 1.7 0.2 7.7 9.1 3.8 3.0 60.1 63.5 43.9 7.4

banking 2012-13 3.2 3.6 1.8 3.1 1.7 2.0 0.5 1.0 6.0 7.4 2.0 0.0 9.2 11.0 3.8 3.1 64.7 67.0 52.2 1.2

Sector 2013-14 3.8 4.4 1.8 3.9 2.1 2.6 0.7 1.1 6.1 7.5 2.2 0.1 9.9 11.9 4.0 4.0 61.3 63.4 54.9 3.5

under 2014-15 4.3 5.0 2.1 3.2 2.4 2.9 0.9 0.5 6.8 8.2 2.5 0.1 11.1 13.2 4.6 3.3 61.5 62.4 53.9 3.0

Stress 2015-16 7.5 9.3 2.8 4.2 4.6 6.1 1.3 0.8 4.0 5.2 1.7 0.3 11.5 14.5 4.5 4.5 35.0 35.9 37.1 7.3

2016-17 9.3 11.7 4.1 4.0 5.5 7.9 1.8 0.4 2.7 3.3 0.6 0.3 12.0 15.0 4.7 4.3 22.3 22.0 13.5 7.9

2017-1811.6 14.6 4.6 3.8 6.1 8.6 2.0 0.4 0.9 2.1 0.5 0.1 12.5 16.7 5.1 3.9 7.2 12.7 9.2 2.6

Source: Secondary data available for per cent GNPA, per cent NNPA, per cent RAs on https://rbi.org.in toderive on per cent SAs and per cent RAs


Observations for Table 3During Global Financial Crisis (GFC) period in 2008-09, Restructured Assetsregistered a threefold increase from 0.8 per cent to 2.7 per cent for all thebanks, but majorly by public sector banks followed by private sector banks.This is despite the PCA criteria on CRAR, ROA and per cent Net NPA has meton overall basis during this period. (except individual banks identified underPCA). For all the banks, Restructured assets as a percentage to total stressedassets increased 100 per cent from 26.3 per cent to 54.8 per cent, publicsector bank saw a whooping jump from 28.4 per cent to 60.6 per cent andprivate sector banks from 23.3 per cent to 43.3 per cent.

As criteria of PCA mechanism was met, this increase in Restructured Assetswas not identified or possibly ignored. However, by then the overall bankingsector started crippling with Stressed asset syndrome. Restructured Assetswas not included as a performance parameter to identify stress in Indianbanking sector.

Who and What is responsible for Stressed AssetsDid the economic downturn catch Indian bankers off-guard resulting into NPAand Stressed asset problem? The answer is "Partially Yes". This may be due tointernal and external factors. In a note submitted to the Estimates Committeeof Parliament in August 2018, former RBI Governor Dr Raghuram Rajan hasquoted two causes. An "irrational exuberance from 1994 till 1996" generatedin promoters (of new projects) by the prolonged spell of rapid economic growththat began in 2003, and the government's failure to live up to its commitmentsto the investors. "A large number of bad loans," he pointed out, "were originatedin the period 2006-2008. when economic growth was strong, and previousinfrastructure projects such as power plants had been completed on time andwithin budget. It is at such times that banks (and, needless to say, promoters)make mistakes". Their chief mistake was to "extrapolate past growth andperformance to the future" and accept projects with very little equity capital,that relied almost entirely upon loans. When the upswing ended with the onsetof global recession in 2008 and demand slackened, many projects becameunviable. Rajan placed the remainder of the blame upon "governance problems"for the Central and State governments failure to provide promised inputs,such as land free of encumbrances, coal, power, water, and transportconnections. Unable to generate revenues, the investors ate into their equitycapital to meet the mounting burden of interest payments, till there was noneleft.

There was always discussion on large-scale involvement of corporate-politicalnexus in banking sector as well. Another major reason of high stressed assetswas crippling interest rates that the Reserve Bank imposed on the economy in2010-11 which made this problem more severe for industrial sector. Theaffliction from which the economy has been suffering for most of the past 10

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years is the unrelenting regime of very high real rates of interest that the ReserveBank of India (RBI) had imposed upon the country. Its origins are to be foundin sudden shift of economic objectives, at the end of 2006, from promoting'inclusive growth' to controlling inflation, and it is a challenging task for theRBI. The only way that a central bank can balance this is by squeezing creditand raising the real rate of interest. The negative effect of these macroeconomicpolicies resulted in increasing in inflation from 6.2 (average consumer priceindex (CPI)) pre-crisis, to 9.1 in 2008-09 and 13 in 2009-10 (PlanningCommission, 2014).

While the government were claiming expediting project clearances through theCabinet Committee on Investment (CCI) official numbers tell a different story.Figures compiled by the Ministry of Statistics and Programme Implementation(MOSPI) reveal that as many as 301 central sector projects, each involving aninvestment of more than Rs 150 crore, have been delayed resulting in costoverruns to the tune of a whopping Rs.1.74 lakh crore. Apart from this massiveinvestment not being made available to revive the economy and create jobs,the cost of implementing these projects shot up due to inflation. This resultedin additional borrowing by the industry from financial institution to meet theInflated project cost and complete the project timeline. However, there wassignificant delay in implementation of these projects due to various reasonslisted as delay in land acquisition, rehabilitation and resettlement problems,fund constraints, delay in forest and environmental clearances, law and orderproblems, right-of-way or right-of-use issues. The time overrun and cost overruncreated a vicious cycle for the industry and financial institution. This is clearwhen one studies the official Economic Survey for 2012-13, where themoderation in growth was primarily attributed to weakness in industry whichregistered a growth rate of 3.5 per cent and 3.1 per cent in 2011-12 and 2012-13, respectively. This came down even further during the 2013-14 fiscal withthe manufacturing sector contracting.

As the rise in wholesale prices slowed in 2012, the government began toseriously consider lowering the cost of borrowing to revive the economy.However, with citing the inflationary threat in future, government could notlower the interest rates and marginally increased policy interest rates. As such'supply-side' inflation is curbing credit and pushing up the interest ratedepresses production, without bringing down prices. Persisting with a high-interest rate policy, therefore, led to 'stagflation'. That is what India had beensuffering from for the past seven years. In India, by allowing the RBI to makeprice stability the sole goal of policy the elected government sacrificed growthat the altar of stability.

But the second, more pressing, reason was the imperative need to keep notprices, but the exchange rate stable. This gained in importance with everypassing year of high-interest rates, because these forced investors to borrowabroad, where loans were available at rates as low as one to three per cent, tokeep their interest burden down.


Graph 2FX Rate Trend from December 2004 to December 2018. (1 USD = INR)

Source: https://www.indiamacroadvisors.com/page/category/economic-indicators/financial-markets/exchange-rate/

Observations for Graph 2Forex rate trend from December 2004 to December 2018 shows impact onimported capital equipment prices resulting in project cost over-run financeby banks. Indian rupee sharply depreciated from March 2008 to March 2009by 27.5 per cent and then from March 2011 continue to depreciate till December2018 and peaked at INR 74 in October 2018.

Graph 3External Debt, Commercial Borrowings (ECB) and Bank Loans from

December 2004 to December 2018

Source: https://www.indiamacroadvisors.com/page/category/economic-indicators.

Observations for Graph 3Between 2008 and March 2015 around 300+ of India's largest companiesborrowed Rs 4.5 lakh crores ($680 billion) abroad, mostly with maturity periodsranging from 3 to 20 years. Between March 2014 and March 2015, after newgovernment became certain, borrowings increased by $ 181.9 billion. Thisraised India's outstanding external debt by 38 per cent to $580 billion. Theeuphoria was so intense that a very large part of the new debt was not hedgedagainst the risk of a fall in the value of the rupee. As a result, in 2015, 59 percent of the $580 billion was vulnerable to devaluation.

120.3 134.0 139.1 172.4

224.4 224.5

260.9

317.9 360.8

409.4 446.2

474.7 485.0 471.3

529.7

24.8 26.4 26.5 41.4

62.3 62.5 70.7 100.5

120.1 140.1 149.4

180.3 180.7 172.9 202.3

12.6 14.4 16.5 24.6 40.2 43.2 44.8

58.6 72.9 83.6

96.9 101.5 97.6 88.0 85.1

0%

20%

40%

60%

80%

0

200

400

600

2004/12 2005/03 2006/03 2007/03 2008/03 2009/03 2010/03 2011/03 2012/03 2013/03 2014/03 2015/03 2016/03 2017/03 2018/12

300 Prajnan

For the borrowers, maintaining the exchange rate regardless of side effects,therefore, became a matter of life and death. The real, unspoken, goal of'Inflation targeting' was to maintain not price but exchange rate stability at anycost. The new government came to power in May 2014 with the full intentionof restoring rapid growth. In his first ten months in office, Finance Ministryreferred to the need to lower interest rates several times, but somehow lostsight of this goal at the precise moment when inflation disappeared from theeconomy. Between 2014 and the present date, demand inflation, which isimperfectly reflected by the WPI, has been very close to zero. But lending ratesto industry have remained above 11 per cent. The real rate of interest istherefore, probably the highest anywhere in the world today. Since the samehigh rates will simultaneously kill the demand for housing and make car,refrigerator loans unaffordable, investors will be hit from both sides. At suchhigh rates, investing nature of cyclical businesses, asset-heavy and have longworking capital cycles are more prone to financial stress. The interest paymentscan double capital costs in as little as seven years – long before they startyielding returns. This explains the presence of such a large number ofcompanies were under Corporate Debt Restructuring (CDR) mechanism, whichare facing stress due to high debt and interest rates.

Table 4Restructuring Cases under CDR Mechanism

(Since Inception in 2001 to till discontinuation in February 2018)

(i) Overall Status (Since Inception) (Rs. Crore)

Total Cases Rejected before Cases under TotalReferences Received Admission or consideation Cases

by CDR Cell Approval of CDR EG Approved(1) (2) (3) (4)

No. of Aggregate No. of Aggregate No. of Aggregate No. of AggregateCases Debt Cases Debt Cases Debt Cases Debt

656 474,351 125 70,998 – – 531 403,353

Cases Withdrawn Cases exited Live case of (7) Packages of (7) Packageson account of successfully in CDR Implemented under

package failure Implemented

(5) (6) (7) (8) (9)

No. of Aggregate No. of Aggregate No. of Aggregate No. of Aggregate No. of AggregateCases Debt Cases Debt Cases Debt Cases Debt Cases Debt

287 169751 110 84566 134 148,238 134 148238 – –


Industry-wise Classification of Live Cases :

Sr. Industry No Aggregate Debt Debt in %No. (Rs Crore)

1. Iron & Steel 30 28,029 18.91%

2. Infrastructure 10 26,730 18.03%

3. EPC 5 23,522 15.87%

4. Engineering 7 14,472 9.76%

5. Construction 9 11,888 8.02%

6. Textiles 18 10,558 7.12%

7. Telecom 3 5,447 3.67%

8. Pharmaceuticals 6 4,877 3.29%

9. Manufacture 3 3,630 2.45%

10. NBFC 2 3,398 2.29%

11. Sugar 7 2,532 1.71%

12. Power 5 2,458 1.66%

13. Coke & Coal 1 2,155 1.45%

14. Auto Anciliary 2 1,570 1.06%

15. Ship-Breaking/Ship Building 2 1,410 0.95%

16. Computers 1 1,328 0.90%

17. Cement 4 1,108 0.75%

18. Paper/Packaging 4 515 0.35%

19. Auto Components 2 502 0.34%

20. Hospitality 1 456 0.31%

21. Service 1 367 0.25%

22. Chemicals 1 315 0.21%

23. Fertilizers 2 261 0.18%

24. Other (Jewellery, Liquor, edible oil etc) 1 152 0.10%

25. Cables 2 144 0.10%

26. Metal (Non-ferrous Metals) 1 134 0.09%

27. Rubber 1 113 0.08%

28 Food & Food 1 70 0.05%

29 Education 1 60 0.04%

30 Plastic 1 26 0.02%

Total 134 148,239 100.00%

302 Prajnan

(A=B+C+D) (B) (‘C) (D)

Financial Total Aggregate Cases Aggregate Cases for Aggregate Approve AggregateYear References Debt Rejectd/ Debt Restructuring Debt Cases Debt

Received (INR Crs) Closed Packages (INR Crs) (including (INR Crs)(Nos) (Nos) (INR Crs) (Nos) withdrawn/

Exited)(Nos)

2008-09 225 95,815 29 5,018 12 4,261 184 86,536

2009-10 256 115,990 32 7,050 9 4,641 215 104,299

2010-11 305 138,604 42 9,667 21 18,023 242 110,914

2011-12 392 206,493 59 20,817 41 35,161 292 150,515

2012-13 521 207,990 87 36,894 33 32,083 401 229,013

2013-14 622 429,989 111 57,540 35 42,005 476 330,444

2014-15 655 474,002 125 70,998 – – 530 403,004

2015-16 655 474,002 125 70,998 – – 530 403,004

2016-17 656 474,351 125 70,998 – – 530 403,004

2017-18 656 474,351 125 70,998 – – 531 403,353

(Amount in INR Crs)

Source: CDR Cell site www.cdrindia.org updated up to February 2018

Observations for Table 4Cumulative total cases received to CDR cell shows increase from 305 nos in2010-11 to more than 622 nos in 2013-14 within the span of three financialyears with whooping aggregate debt under restructuring having increase fromINR 1,38,604 Crs to INR 474,351 Crs. More than 50 per cent restructuringcases were from Iron and Steel (Metals), Infrastructure, EPC (Power),Engineering and Construction sector which need huge capital with longer break-even period.

When these sectors faced a slowdown stressed assets accumulated forrestructuring under CDR mechanism. Many times, these sectors, being toodependent upon government policies and regulatory environment were left toface project delays and time over-run for the projects. Many companies wereover-expanded during boom period funded by Financial institution, leavingthem with obligations that they could not repay. Restructuring cases underCDR (from the balance sheet of the Financial Institutions) were likely NPAswhich were under tremendous financial stress during this period. As per RBIreports on Banking operations and Performance, major stressed assetsaccumulated in industry sector (compared to agriculture, service and retail)since 2011-12 and that too concentrated in subsectors like metals,infrastructure including power, construction as observed in Corporate DebtRestructuring over the years.


Graph 4Asset Quality Positions in various Sectors from

March 2012 to March 2018

Graph 5 Asset Quality in various Sub-sectors from

March 2016 to March 2018

Source: RBI Financial Stability Reports up to December 2018

Section IVConclusion

Stressed Assets have registered a steady growth since 2011; but if we were tolook at NPAs, the growth was muted until 2014 and has dramatically increasedparticularly after 2015-16 as per Table 3. Recognition as NPA of several loansafter 2015-16, which banks had then considered to be standard assets onlyafter RBI undertook an Asset Quality Review (AQR). NPAs went up from 4.3per cent in 2014-15 to 11.6 per cent in 2017-18 for all Indian banks.

0.0

5.0

10.0

15.0

20.0

25.0

30.0

35.0

40.0

45.0

50.0

Mining andquarying

Foodprocessing

Textiles Paper andProducts

Chemicals &Products

Rubber,plastic &Products

Cement andProducts

Metals andproducts

Engineering Vehicles,parts &

Equipments

Gems andJewellyery

Construction Infrastructure

Mar-16 16.3 17.7 21.3 16.0 11.8 10.8 19.0 34.4 16.5 13.8 13.2 27.1 16.7

Mar-17 21.1 21.4 27.5 22.8 8.9 8.6 34.6 45.8 19.4 25.6 13.0 24.5 18.3

Mar-18 26.8 22.3 22.3 28.0 8.8 5.2 18.1 46.3 34.4 22.5 25.4 24.0 22.6

Mar-19 26.7 17.6 16.1 16.9 8.5 9.2 14.2 28.5 25.0 18.4 21.5 21.8 17.8

Stressed Advance Ratio for major subsectors within Industry

Mar-16 Mar-17 Mar-18 Mar-19

-

5.0

10.0

15.0

20.0

25.0

30.0

Agriculture Industries Services Retail Agriculture Industries Services Retail

GNPA Stressed Assets

Asset Quality in Various Sector March 2012 to March 2019

Mar-12 Mar-13 Mar-14 Mar-15 Mar-16 Mar-17 Mar-18 Mar-19

304 Prajnan

The normal principle for restructuring is that an account should be downgradedif any amount is forborne, however, RBI allowed for restructuring of debt withoutthe need for an asset quality downgrade if the restructuring plan met certainconditions. Banks continued to show these restructured assets as "Standard"without evaluating the reality on case to case basis. CDR mechanism workedwell initially and in later years, its asset quality forbearance was used more asa tool for avoiding recognition of non-performance of stressed assets and lessfor their effective resolution. Restructuring through CDR mechanism waswonderful tool to borrowers to accommodate their debt payments during crisis;however, over the years this tool has been increasingly misused to re-classtheir NPAs in the name of restructured assets since 2010-11.

The increasing NPA of the banks over last five years explain the logic behindthe decline in restructuring assets. Banks were showing huge loan accountswithout addressing their restructuring assets issue as banks had to provisiononly 5 per cent for restructured assets compared to 15 per cent for the NPA. Ifthe banks had to classify the defaulters into NPA then, the balance sheet wouldnot look great. But instead, they can classify it under asset restructuring andsave on 10 per cent on the provisions.

With RBI stating that all the banks need to make provision of 2.5 per centevery quarter by March 2017 for stressed loans, banks have been showingdeclining trend in assets restructuring. Therefore, with RBI's push to recognizethe stresses assets and consider them into NPA wherever necessary, more ofrestructured assets were re-class to NPA in last three years. The (Asset QualityReview) AQR conducted by the banking regulator found several restructuredadvances, which were standard and restructured in the banks' books thatneeded to be reclassified as non-performing.

Therefore in 2015-16, large proportion of structured advances slipped intoGross NPAs though there is marginal increase in stressed assets over last twoyears. On analysis of the Reserve Bank's data, it has been established that thestress in bank assets has been mounting since 2011 under restructuring andhas materially crystallized in the form of Gross Non-Performing Assets (NPAs).

Past data shows that stress has been parked under Restructured assets undervarious available mechanism in the system including Corporate DebtRestructuring (CDR). As quoted during speech given by then RBI deputyGovernor Dr K C Chakraborty at the Corporate Debt Restructuring Conference2012 organized by Centrum Group at Mumbai on August 11, 2012, quotedthat CDR was an effective tool especially during the time of crisis, with its prosand cons. CDR was a beautiful innovation to protect the values of both thecorporates under distress and the credit portfolio of their lenders. Due to theextraordinary rise in the number and volume of advances being restructuredunder the scheme in recent times, it has come under media scanner and engagedthe attention of the financial market players, the borrowers, the regulators


and the policymakers. However, it appears that the provisions of the CDRmechanism have not been used very ethically and judiciously, giving rise to theunprecedented increase in cases under restructuring.

The general approach of bankers to stress in large assets has been one ofavoiding the recognition of non-performance of such accounts. Therefore, wehave a history of many cases of failed restructuring as the schemes were usedfor avoiding a downgrade rather than resolving the asset. Prolonging the trueasset quality recognition suited both the bankers and the borrowers. The bankercould make their books look cleaner than they were; the borrower could avoidthe defaulter tag even while, in fact defaulting.

The sum of Stressed Assets has reached the highest even figure of Rs. 11,04,772crores, or $158 billion by March 2018. Stressed assets on the books of Indianbanks are getting higher than their net worth. The situation is most acute forpublic sector banks where stressed assets are now contributing 92 per cent(Rs.10,25,826 crores or $146 billion), of total banking stressed assets as ofMarch 2018. Some banks are under the Reserve Bank's Prompt CorrectiveAction (PCA) having failed to meet asset-quality, capitalization and/orprofitability thresholds; others meet these thresholds for now but no one cangive a guarantee of other banks and their asset quality which may bring themunder the ambit of PCA in near future. Only two public sector banks reporteda net profit in the year ended March 31, 2018 – Vijaya Bank and Indian Bank.The remaining 19 state-owned banks collectively posted a net loss of over Rs87,583 crores.

As this data filtered into the public conscious, it became clear that India wassuffering from a "twin balance sheet problem", where both the banking andcorporate sectors were under stress. Typically, countries with a twin balancesheet (TBS) problem follow a standard path. Their corporations over-expandduring a boom, leaving them with obligations that they can't repay. So, theydefault on their debts, leaving bank balance sheets impaired, as well. Thiscombination then proves devastating for growth, since the hobbled corporationsare reluctant to invest, while those that remain sound can't invest much eithersince fragile banks are not really in a position to lend to them.

In March 2018, Stressed Assets stands at 12.5 per cent of Gross Advanceswith Restructured assets at 0.9 per cent and Gross NPAs at 11.6 per cent, isthe highest in the last decade. Due to implementation of various policy andlegal measures, it is slightly improved to 10.8 per cent in September 2018.RBI's stress test of the banking sector indicated that projected Gross NPAmaybe around 10.4 per cent in March 2019 likely to remain same in September2019. Public sector banks are likely to continue the worst hit as their GrossNPA may increase to 14.5 per cent by September 2019 under Medium andSevere Stress.

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Graph 6Projected Gross NPAs for Schedule Commercial Banks

Source: RBI Financial Stability Reports up to December 2018.

The stress assets are crippling the banking system from lending to newbusinesses. This has been holding back banks from reducing interest rates asthey have to provide for losses stemming from these large bad accounts.Stressed assets are cancerous and removing cancerous tumour out of ourbanking system is important to sustain and achieve GDP growth.

Recent Policy and Legal Framework MeasuresIn 2014, the RBI creation of Central Repository of Information on Large Credits(CRILC), a loan database of all loans given out by banks of value more thanrupees five crores, important decision to have information of loan defaults atthe other banks. Execution of "Indradhanush framework" with its seven-pointsplan decided in August 2015. This includes regulation of public sector bankstop posts appointments, establishment of Banks Board Bureau (BBB),Capitalization Adequacy, De-stressing, Empowerment, Framework ofaccountability and Governance reforms to improve efficiency and transparency.

The Government of India issued an ordinance on May 6, 2017, to amend theBanking Regulation Act, 1949, whereby it can issue order to Reserve Bank ofIndia to issue directions to any bank to initiate the insolvency resolution processunder the provision of Insolvency and Bankruptcy Code 2016, against defaultingentities. The ordinance also empowers RBI to appoint members in thecommittees constituted for resolution of stressed assets. This enforcesborrowers and lenders to come to common platform else face liquidationprocess. The promulgation of Banking Regulation (Amendment) Ordinance,2017 inserting two new sections 35AA and 35AB.While the new Section 35AAinserted by Ordinance empowers the government to authorize the RBI to issuedirections to banks as it deems fit to initiate insolvency process framework incase of a default under the provisions of the IBC 2016, the Section 35 AB givespower to the RBI to specify one or more authorities or committees to advisebanks on resolution of stressed assets.


Implementation of Insolvency and Bankruptcy Code (IBC), 2016 for non-financial entities for time-bound resolution of issues related to Stressed assets.The IBC was enacted to consolidate and amend the laws relating toreorganization and insolvency of corporate persons, partnership firms andindividuals in a time-bound manner. A revised framework for "Resolution ofStressed Assets" has been introduced in February 2018 in line with theInsolvency and Bankruptcy Code. Under revised framework, it was mandatoryto provide for a strict 180-day timeline for banks to agree on a resolution planin case of a default or else refer the account for bankruptcy. Banks were toldto start the resolution process as soon as a borrower defaults on a term loanand were given 180 days to cure it, failing which the account would have to bereferred to the National Company Law Tribunal (NCLT). However, SupremeCourt order dated April 2, 2019, nullifying February 2018 circular saying thatgeneric circular directing banks to take recourse to Insolvency and BankruptcyCode was beyond the powers of Section 35AA of the Banking Regulation Act.The Court held that reference to IBC can be made only on a case to case basisand that there cannot be a blanket direction to that effect with strict 180 daystimeline. The Supreme Court decision provided flexibility to banks torestructure stressed assets without going through the formal bankruptcyresolution system. Therefore, RBI reintroduced new guidelines on June 7, 2019,and provide greater flexibility to banks in deciding which stressed assets to beresolved using the IBC. The IBC is a very effective mechanism that has beenupheld by courts in its entirety and the banks' decisions to resolve stressedaccounts through IBC could be led by whether such accounts involve willfuldefaults or have become stressed due to adverse business conditions andenvironmental factors.

The new guidelines on Resolution of Stressed Assets provide a system of strongdisincentives in the form of additional provisioning for delay in initiation ofresolution or insolvency proceedings. The new framework makes inter-creditoragreements mandatory and provides for a majority decision to prevail. Majorfocus is on early identification and reporting of stress, lenders should recognizestress in loan accounts immediate on default by classifying such assets asSpecial Mention Accounts (SMAs) with following categories:

Basis for Classification

Sub-category Principal or interest payment or any other amount wholly or partlyoverdue between

SMA-0 1-30 days

SMA-1 31-60 days

SMA-2 61-90 days

Special Mention Account (SMA) is an account which is exhibiting signs ofincipient stress resulting in the borrower defaulting in timely servicing of herdebt obligations, though the account has not yet been classified as NPA as per

308 Prajnan

the extant RBI guidelines. As early recognition of such accounts will enablebanks to initiate timely remedial actions to prevent their potential slippagesinto NPAs. Recent Prudential Framework for Resolution of Stressed Assetsreleased on July 7, 2019, provides guidelines for Implementation of ResolutionPlan. This includes all lenders must put in place board-approved policies andtimeline for Resolution of Stressed Assets. It is expected that the lenders initiatethe process of implementing a Resolution Plan (RP) even before a default andreview of borrower account within 30 days of such default i.e. called as "ReviewPeriod". During these 30 days review period, lender may decide on ResolutionStrategy, nature and approach of implementation of RP, choose legal proceedingunder IBC or recovery.

Graph 7Stress in Large Borrowing Accounts in PSBs and PVBs

as on September 2019

-

5.0

10.0

15.0

20.0

25.0

30.0

35.0

40.0

SMA 0 SMA 1 SMA 2 RSA NPAs Stress

9.5

2.8 1.0

2.6

23.1

39.0

4.2

1.3 0.7 1.7

17.6

25.5

2.7 1.6 2.2 1.5

17.3

25.3

3.7 1.5

0.3 0.5

7.9

13.9

2.8

- 0.5 0.5

8.9

12.7

3.0 1.9 1.2 0.4

9.5

16.0

Stress in Large Borrowing Accunts

Mar-18 Mar-19 Sep-19 Mar-18 Mar-19 Sep-19

PSBs PVBs PSBs PSBs PSBs PSBsPVBs PVBs PVBs PVBs PVBsPSBs

As on September 2019, above graph shows Stress assets rise in both PSBsand PVBs in SMA 2 account. Gross NPAs are reduced for PSBs, however, rosefor PVBs. Notwithstanding the enhanced resolutions through the insolvencyand bankruptcy code, the overhang of NPAs remains. The health of the bankingsector hinges around a turnaround in macroeconomic conditions. While stressremain elevated, banks have seen major relief from large resolution underIBC.

With the implementation of IBC, RBI has also withdrawn the existing mechanismwhich included Corporate Debt Restructuring (CDR) scheme, Strategic DebtRestructuring Scheme (SDR) and Scheme for Sustainable Structuring ofStressed Assets (S4A). The Joint Lenders' Forum (JLF) as an institutionalmechanism for resolution of stressed accounts also stands discontinued andall accounts, including such accounts where any of the schemes have beeninvoked but not yet implemented, shall be governed by the revised framework.


On January 1, 2019, RBI introduced guideline for Restructuring of Advancesfor MSME sector and permit restructuring of existing loans to MSMEs classifiedas Standard without downgraded the asset classification. This is subject tocertain conditions with exposure does not exceed rupees 250 Million andrestructuring to be implemented before March 31, 2020.

In December 2018 Finance Minister announced capital infusion of Rs. 830billion in state-owned banks to strengthen their capacity to lend and come outof RBI Prompt Corrective Action framework. The government also soughtParliament's approval to infuse an additional Rs 410 billion in state-ownedbanks enhance the total recapitalization in the current fiscal from Rs 650 billionto Rs 1.06 trillion.

RecommendationsPropose three recommendations will support Indian banking sector to controlissue of Stressed Assets in future.

Recommendation 1

PCA framework for banks to consider revision in Asset Quality criteria for NetNon-Performing Asset ratio (NNPA): Currently Asset quality criteria considerRisk Threshold 1 >= 6.0 per cent but < 9 per cent. This percentage criteriais after provision by banks towards Gross NPAs but does not include anyprovision towards restructured Assets.

Table 5Risk Threshold

Indicator Risk Threshold 1 Risk Threshold 2 Risk Threshold 3

Asset Quality Net non- >=6.0 per cent >=9.0 per cent >=12.0 per centperforming but but butadvances < 9.0 per cent < 12.0 per cent(NNPA) ratio

In analysis, we can compare past decade data of NNPA ratio with provisiontowards GNPA vs. NNPA ratio with addition of Restructured assets in GNPAi.e. consideration of Stressed Assets.

310 Prajnan

Table 6NNPA Ratio with only GNPA Provision

(Figures in per cent)

Year All Banks PSB PB FB

2006-07 1.0 1.1 1.0 0.7

2007-08 1.0 1.0 1.1 0.8

2008-09 1.1 0.9 1.3 1.8

2009-10 1.1 1.1 1.0 1.8

2010-11 1.0 1.1 0.5 0.6

2011-12 1.3 1.5 0.5 0.6

2012-13 1.7 2.0 0.5 1.0

2013-14 2.1 2.6 0.7 1.1

2014-15 2.4 2.9 0.9 0.5

2015-16 4.6 6.1 1.3 0.8

2016-17 5.5 7.9 1.8 0.4

2017-18 6.1 8.6 2.0 0.4

Source: Own calculations from secondary data.

Table 7NNPA Ratio with Stressed Assets Provision

(Figures in per cent)

Year All Banks PSB PB FB

2006-07 1.6 1.7 1.2 1.4

2007-08 1.8 1.9 1.8 1.5

2008-09 3.8 4.0 3.5 2.5

2009-10 5.6 6.1 3.5 2.4

2010-11 4.6 5.6 1.9 1.0

2011-12 5.9 7.3 2.1 0.8

2012-13 7.6 9.4 2.5 1.0

2013-14 8.2 10.1 2.9 1.2

2014-15 9.2 11.2 3.4 0.6

2015-16 8.6 11.0 3.0 1.1

2016-17 8.2 11.2 2.4 0.7

2017-18 7.0 10.7 2.5 0.5

Source: Own calculations from Secondary data.

Table 7 has established that "Net NNPA ratio with Stressed Assets" would havebreached the "Risk Threshold 1 of >=6 per cent but < 9 per cent" much earlierthan current criteria with Stressed Assets. With implementation of thisrecommendations, early stress would have been recognized six years before


i.e. in 2012-13 with NNPA ratio @ 7.6 per cent vs. 2017-18 with NNPA ratio @6.1 per cent for "All Banks". For public sector banks, early stress would havebeen recognized seven years before i.e. in 2009-10 with NNPA ratio @ 6.1 percent vs 2015-16 with NNPA ratio @ 6.1 per cent. PCA framework with proposecriteria would have been successfully identified early Stress in Indian bankingsector in 2009-10 during global financial crisis period.

As per new guidelines, recognize stress in loan accounts immediate on defaultby classifying such assets as Special Mention Accounts (SMAs). Category SMA2 is for Principal or interest payment or any other amount wholly or partlyoverdue between 61 to 90 days. This category also to be included to arrive onoverall Stressed assets in banking system. Therefore, it has been recommendedthat Net NPA (NNPA) ratio in "Risk Threshold" should be including provisiontowards Stressed Assets i.e. Net Non-Performing Assets plus RestructuringAssets (RAs) plus SMA 2 category assets to align with principal of PCAframework i.e. early warning from the framework. (Risk threshold criteria =NNPAs + RAs + SMA 2)

Recommendation 2

As per IMF report, India were ranking 6th position in NPA listing across theglobal. With latest Gross NPA @ 11.6 per cent of March 2018, we would havejump to 5th position across the globe. Indian banks ranking 17th position forReturn on Assets (ROA) parameter across the globe.

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Table 8Global Ranking of India on NPA, ROA and ROE

(in per cent) (in per cent)

Country NPA

Greece 45.57

Italy 16.35

Portugal 13.30

Ireland 11.46

Russia 10.00

India (Dec 2017) 9.98

Romania 7.96

Spain 4.46

Brazil 3.59

France 3.41

South Africa 3.10

Thailand 3.07

Turkey 2.84

Indonesia 2.56

Argentina 1.84

China 1.74

Germany 1.69

Malaysia 1.55

Singapore 1.40

Japan 1.19

US 1.13

UK 0.81

Source: IMF

Country ROA ROE Country ROA ROE

Argentina 4.49 38.73 Korea 0.49 5.99

Turkey 2.04 18.85 France 0.44 7.00

Hungary 1.93 19.67 UK 0.42 6.18

South Africa 1.70 19.78 Germany 0.37 6.57

Brazil 1.47 13.90 Italy 0.35 4.71

Malaysia 1.44 13.08 US 0.34 2.93

Chile 1.40 16.60 India 0.33 4.51

Russia 1.01 7.94 Japan 0.33 8.11

China 0.92 12.56 Portugal 0.32 3.44

Ireland 0.87 6.13 Greece -0.17 -1.30

Source: https://www.thehindubusinessline.com/opinion/indias-npas-and-the-global-scenario/article24145872.ecehttps://www.thehindubusinessline.com/opinion/indias-npas-and-the-global-scenario/article24145872.ece

With developing countries like US, UK, Japan, China having per cent NPA lessthan 3 per cent, India should target threshold of 3 per cent. Therefore,recommended to introduce one more "Risk Threshold slab =>3 per cent but< 6 per cent". Most of the developed economy having their NPAs less than 3per cent, India should benchmark and target the similar threshold and takenecessary steps to achieve the same. As per latest report, India will be one ofthe fastest-growing economy in the world, will likely to surpass US by 2030.Therefore, we must learn from past and once again shall not have such highpercentage of Stressed Assets in Indian Banking Sector which will paralyseIndian economy in future.

Recommendation 3Effective Performance Evaluation system, corporate governance and createpotent risk management system is critical to the proper functioning of thebanking sector and the economy.


For effective performance evaluation system, various steps has beenimplemented including regulation of public sector banks top postsappointments, establishment of Banks Board Bureau (BBB), capital adequacy,empowerment, framework of accountability and governance reforms to improveefficiency and transparency in the banking sector. Effective Corporategovernance determines the allocation of authority and responsibilities by whichthe business and affairs of a bank are carried out by its board and seniormanagement. Governance weaknesses at banks can result in the transmissionof problems across the banking sector and the economy, same as the experiencein this decade with twin balance sheet issue in Indian banks and corporatesector. Potent risk management system, RBI released circular on April 27,2017, and clarified role of "Chief Risk Officer (CRO)" to bring uniformity inapproach followed across all the banks. This is part of effective riskmanagement system to have separation of credit risk management functionfrom credit sanction process and in alignment with "Guideline notes onManagement of Credit Risk and Market Risk", released by RBI dated October12, 2002. However, in past in-spite of these guidelines in place and clarifiedrole of CRO, still banking sector face the serious challenges to identify potentialrisks while credit sanction process including restructuring.

With all above background, it is recommended to enhance corporate governanceat Schedule commercial banks while underwriting any credit proposal andResolution Plan (RP) with implementation of RAROC (Risk-Adjusted Returnon Capital) methodology and effective decision-making role of CRO (Chief RiskOfficer).

Effective Implementation of RAROC ConceptRisk-adjusted return on capital (RAROC) concept is modified Return onInvestment (ROI) which consider likely risk / expected loss into account

Revenue – Expenses – Expected loss + Income from CapitalRAROC =

Capital

After independence, as the role of commercial banks were limited to providingworking capital financing for short periods. The Development FinancialInstitution (DFIs) were set up to finance the development on long term basisfor the significant sectors of the economy like infrastructure sector, industry-specific finance, etc. Over a period of time, DFIs like IDBI, ICICI, SIDBI, IRBI,NABARD, HDFC, etc., develop their expertise for credit sanction process andrisk management system. Post liberalization of economy in 1991 and after2000-2001 the role of DFIs and commercial banks have blurred due tooverlapping of their functions. Since then commercial banks are activelyinvolved in development financing similar to DFIs especially after the mergerof ICICI and IDBI within the banking system. As prolonged spell of rapid

314 Prajnan

economic growth that began in 2003, commercials banks were in learningprocess for credit appraisal and risk management system while lending.Expertise of DFIs over the decades in credit appraisal and risk managementsystem could not be completely developed in commercial banks. For Example,before 2008 China Olympics Global Steel Prices went up to $1200 / tonne dueto demand and suddenly within six months end of Olympics, these prices wentdown less than $500 / Tonne. However, underwriting credit proposal wouldhave not evaluated with RAROC concept for such expected huge loss due tomarket risk. Prior to the economic crisis of 2008, several steel makers hadtaken huge debt exposure due to good demand and increasing market prices.Slowdown in China causes nearly every Indian Steel Company to record hugelosses. Therefore, we could see major steel companies are under stress andmostly recommended for Insolvency under IBC. Banks are taking major haircuton credit given to these companies during insolvency process.

Therefore, it has been recommended to develop a specialized industry-specificregulatory and supervisory cadre for approval of credit appraisal > INR 2,000Crores (or separate threshold for specific Industry) with RAROC concept. Therehas been a move globally towards building specialized teams of banksupervisors. Even in the Indian context, some incidents in the financial sectorhave underscored the need for specialisation in supervision and regulation.

Enhance Effective Decision-making Role of Chief Risk OfficerAs per April 2017 notification, current CRO role is clearly advisory and didnot take part in decision-making process. It is very clear that Chief Risk Officers(CROs) has to play an effective role and should be directly accountable toManaging Directors (MDs), Chief Executive Officers (CEOs) and RiskManagement Committee of the Board.

Therefore, it is recommended that CRO role to be enhanced in the followingmanner

(i) Central cadre of CRO has to be developed and transferred between the banksafter specific tenure

(ii) A threshold weightage (at least 30 per cent) of CRO advice to consider indecision-making process of credit sanction and restructuring proposal. "CROcadre" to provide effective risk management information to "Regulatory andSupervisory cadre" on lessons learn based on past credit or restructuringproposal for effective implementation of credit appraisal and risk managementsystem in future projects across sectors. This will enhance balance betweenperformance evaluation, corporate governance and risk management systemin banking sector.


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