Banks’ balance sheet clean-up imperative for growth, says Raghuram Rajan

The ongoing clean-up of bank balance sheets will help spur economic growth and improve the lenders’ profitability, Reserve Bank of India (RBI) Governor Raghuram Rajan said on Thursday. The RBI had conducted an asset quality review (AQR) of banks and identified specific accounts, which banks have to identify as non-performing in two quarters, October-December and January-March. As a result, bad loans have hit banks’ profitability in the third quarter with most of them posting heavy losses in Q3.

“While the profitability of some banks may be impaired in the short-run, the system, once cleaned, will be able to support economic growth in a sustainable and profitable way,” Mr. Rajan told delegates at the CII Banking Summit.

State Bank of India reported 62 per cent drop in its net profit on the back of over Rs. 20,000 crore rise in non-performing loans or bad loans.

Private banks, which are in a much better shape on the asset quality front, saw their business growing much more than their public sector counterpart, he said.

“Non-food credit growth from public sector banks, the more stressed part of the system, grew at only 6.6 per cent over the calendar year 2015… In contrast, non-food credit growth in private sector banks was 20.2 %, per cent.”

On the current decline in share prices of banks, Mr. Rajan said: “Part of the reason is that some bank results, mainly public sector banks, have not been, to put it mildly, pretty. Clearly, an important factor has been the Asset Quality Review conducted by RBI and its aftermath.”

There are two polar approaches to loan stress. One is to apply band aids to keep the loan current and hope that time and growth will set the project back on track, he said. An alternative approach is to try to put the stressed project back on track rather than simply applying band aids. This may require deep surgery.”

During the fifth bi-monthly review of monetary policy in December last year, Mr. Rajan had said he intended to clean-up bank balance sheets by March 2017.

Justifying the move to ask banks to classify loans that were identified during the AQR as bad loans, Mr. Rajan said loan classification is merely good accounting — it reflects what the true value of the loan might be. “It is accompanied by provisioning, which ensures the bank sets aside a buffer to absorb likely losses. If the losses do not materialize, the bank can write back provisioning to profits.”

The Indian banking sector is seeing rise in stressed assets over the last three years. According to RBI data, stressed asset, that is gross NPA plus standard restructured advances, as a percentage of advances moved up to 11.3 per cent as on September 2015 as compared to 9.2 per cent in March 2013.

Mr. Rajan tried to ally fears of the market participants who are worried about the amount of bad loans that will be added to the system.

“There are some wild claims being made by some financial analysts about the size of the stressed asset problem. This verges on scare-mongering. Our projections are that any breach of minimum core capital requirements by a small minority of public sector banks, in the absence of any recapitalization, will be small.”

The banks will need government equity or preference share infusion, he said. On its part, RBI will provide whatever liquidity is needed by any bank, he said.

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GDP expanded 7.2 % last year, slower than estimated

India’s economy expanded 7.2 per cent in the financial year ended March 2015, marginally slower than the previous estimate of 7.3 per cent. “Real GDP or GDP at constant (2011-12) prices for the years 2014-15 and 2013-14 stands at Rs.105.52 lakh crore and Rs. 98.39 lakh crore respectively, showing growth of 7.2 per cent during 2014-15, and 6.6 per cent during 2013-14,” according to a statement released by the Statistics and Programme Implementation Ministry.

In terms of real Gross Value Added, that is, GVA at constant (2011-12) prices, there has been a growth of 7.1 per cent in 2014-15, as against a growth of 6.3 per cent in 2013-14, according to the statement.

RBI Governor Raghuram Rajan had on Thursday warned that we should be careful about how we measure growth. People are shifting between activities, he said, but it is important that when they shift to a new area, they are creating value.

The overall consensus seems to be that, despite the confusion in the national accounts caused by the revised methodology of computing GDP and GVA, there does not seem to be any other option but to use them.

“Raghuram Rajan has said that you should be careful about the GDP numbers. But these are the official numbers, and you need them as a benchmark,” M Govinda Rao, Professor Emeritus at the National Institute of Public Finance and Policy, told The Hindu.

The buoyancy of the indirect tax numbers have also helped, added Mr Rao.

“Around 80 per cent of economists feel that the way the new GDP numbers are being calculated has yielded in a higher estimate than reality. The belief is that the economy is actually growing at 5-6 per cent,” Ashok Gulati, Infosys Chair Professor at the Indian Council for Research on International Economic Relations said, adding that there was no deliberate attempt to fudge the numbers. The problem lies with the methodology.

The problems with the GDP data come when they are analysed on a sectoral basis and also when they are compared to the other indicators of economic performance.

“If you look at all the other indices, growth in capital stock, exports, agriculture, industrial production, etc, then this (the GDP growth rate) will reconcile with none of them. There needs to be an external committee than can audit these numbers and bring credibility back to the government’s numbers,” said Rajiv Kumar, senior fellow at the Centre for Policy Research.

High-employment sectors such as agriculture are growing very slowly, adding to the concerns. The revised numbers peg the agricultural GVA at 1.3 per cent in 2014-15, up from the 0.6 per cent provisionally estimated earlier. The secondary sector, comprising manufacturing and construction, grew at 5.4 per cent in the same period, down from the estimated 6.5 per cent. The services sector grew at a robust 10.3 per cent.

“What each sector is saying is important. More than 50 per cent of the workforce is employed in agriculture, but the sector is growing at less than 2 per cent. Now, you can say that there was a drought, but it is the job of government policy to deal with such situations,” Mr Gulati said.

Gross Capital Formation, a proxy for economic activity, decreased marginally from 36.2 per cent of GDP in 2013-14 to 35.9 per cent in 2014-15.

“At constant (2011-12) prices, the private final consumption expenditure [a measure of individual spending capacity and inclination] is estimated as Rs. 55.20 lakh crore and Rs. 58.64 lakh crore, respectively for the years 2013-14 and 2014-15. The corresponding rates of PFCE to GDP for the years 2013-14 and 2014-15 are 56.1 per cent and 55.6 per cent respectively,” according to the ministry statement.

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RBI to comb bank books to unearth hidden bad loans

The Reserve Bank of India Bank is set to intensify its scrutiny of banks’ financial accounts during the annual financial inspection process as the banking regulator races to achieve the goal of cleaning up bank balance sheets by March 2017.

The RBI’s steps to tighten the screws on provisioning for bad loans could see industry wide profitability, especially at state-run banks, come under strain over the next six quarters as more and more stressed assets are unearthed.

Hitherto, there has been a discrepancy in the non-performing asset numbers that banks report and what the central bank finds during the annual inspections. It is often the case that a loan is kept as a standard asset despite there being incipient signs of stress. “Whenever such a case is found, banks are told to make appropriate provisioning,” said a banking industry source. Banks have to make a five per cent provision for standard assets while provisioning for a sub-standard asset is 15-20 per cent. Sub-standard asset is the first category of non-performing asset (NPA), that is when interest or principal is due for more than 90 days.

RBI Governor Raghuram Rajan has set March 2017 as the deadline to complete the clean up exercise. This is because, banks have to make a significant amount of provisioning, and instead of doing it at one go — which could severely impact their bottomline — they can spread it over six quarters.

“Given that banks have more powers we can now be a little more careful about recognition and the first step of that was to do away with forbearance starting April 1, but the next step is to make sure that what should be classified as A is classified as A and not B,” Dr. Rajan said on Tuesday, during the monetary policy review briefing. “So this is underway, and we hope that” by March 2017 the clean-up will have been done, the RBI Governor said.

The gross NPAs of public sector banks were 6 per cent at the end of June, up from 5.2 per cent in March. According to RBI data, industry wide stressed assets, that is gross NPA plus standard restructured advances, as a percentage of gross advances rose to 11.1 per cent as on March 2015 as compared with 9.2 per cent two years earlier. Public sector banks share a disproportionate burden of the stress.

The opaque nature of disclosure by public sector banks has also caught the attention of investors as most of these banks’ shares are trading at a discount to their book value. The subdued valuation has in turn limited their ability to raise capital from the market. While the government has promised capital infusion of Rs.70,000 crore over four years in public sector banks, that amount is seen as inadequate given the provisioning requirement and also the higher capital needed to comply with the Basel-III framework.

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