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With system-wide NPAs worse than Pakistan & Botswana, the Indian banking sector is in a mess

The Indian banking sector is in deep trouble. No, I am not referring to the 25%-50% crashes the stock prices of lenders such as DHFL,IIFL or Edelweiss or the huge liquidity crunch that threatens the operations of several lenders forcing RBI to raise the single-borrower lending cap for NBFCs by 50% (from 10% of assets to 15%). These are, but, temporary blips in the larger scheme of things. Finance professionals use the term Asset-Liability-Mismatch (ALM) for this kind a problem resulting from the divergence between the tenure of a lender’s borrowings and the maturity of its loan assets. During credit-booms, this is less of a problem as liquidity needs can easily be met through short-term borrowings such as commercial papers. However, when market conditions are not favourable, liquidity is either unavailable or too expensive, thus leading to financial instability The credit quality situation in the banking sector is nothing short of unprecedented. At 12.3% of loans outstanding, Non- Performing-Assets (bad loans) are at unsustainable levels. Deposit growth in FY 18 was paltry, coming in at 7%- the worst in atleast 10 years. Credit growth was an anaemic 10%, down from the heydays of 2011 when it was 21.5%. The banking industry (at an overall level) was unprofitable in the latest financial year, losing Rs 43,000 crores – appalling given it is the only industry in the world that can legally create money out of thin air! A rates have gone up steadily (from 3.9% in FY 14 to 12.3% in FY 18), credit growth has slowed significantly (from 13.9% in FY 14 to 8.2% in FY 17 before recovering slightly to 10% in FY 18). All this while, the Return on Assets (measure of how profitable the banks are) have plummeted from 0.7% to -0.3%. One explanation for the banking sector stress often cited by experts is – Demonetisation They argue that the withdrawal of nearly Rs 15 trillion in currency led to a massive monetary shock that stressed businesses and individuals alike, creating the current banking crisis. Another explanation for the massive asset quality stress, especially in the MSME loan portfolio is that the Goods and Services Tax adversely affected the financial health of small businesses due to uncertainties involved in the transition process. A close look at the NPA data paints a very different picture. While it is not my contention that demonetization & GST had no effect on the NPA problem the banking system had a clear problem even before either event, with overall Gross NPA rate of 9.4% in September 2016 (before both Demonetization and GST). Indeed, overall banking GNPA did go from 7.9% in FY 16 to 9.6% in FY 17 and then again to 12.3% in FY 18. So, while it is entirely plausible that GST, Demonetization and RBI’s new prudential norms exacerbated an existing problem, the data simply doesn’t support the explanation that the bad-loan crisis is due to any of these factors.

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