National Asset Reconstruction Company Ltd., Priority Sector Lending, and Non-Performing Assets in the Indian Banking System

A Budgetary (2021-22) Perspective

Non Performing Assests (NPAs) have been a challenging issue with the Indian Banking System. The Union Budget 2021-22 proposed the formation of National Asset Reconstruction Company Ltd (NARCL) to manage the NPAs. It would be interesting to explore the related points in the context of Agricultural and Rural settings i. e. Priority Sector Lending (PSL) in India. In preview of this, the following article highlights the key discussion points of our ARF (Agricultural and Rural finance) research group at CRDIST, IIT Kharagpur.

1. Issues in the Banking Sector

Public-sector banks’ role in the banking sector and contribution of Priority Sector Lending (PSL) to the national development is widely acknowledged, but their poor financial return has been a matter of deep and enduring concern. Despite increasing the total outstanding credit amount, the credit-to-deposit (C-D) ratio of Scheduled Commercial Banks has declined (fig. 1). Indian banks specially public sector banks have a problem with unpaid loans, which has aggravated over the past decade. Demonetization resulted in increased deposits for the banks, but it reduced the amount of liquid cash in the public’s hands. Moreover, uncertainties like the COVID-19 pandemic have further reduced the general inclination to borrow money from the banks. As a result, the banking credit growth has decreased from 7.1% (as of Dec 2019) to 6.1% (as of Dec 2020) [Economic Survey, 2020-21].

Fig. 1 Credit disbursed by SCBs and their C-D ratio during 2009-2019 (Authors’ compilation)

2. Public vs. Private-Sector Banks

Public-sector banks account for more than 70% of the transactions carried out by all Scheduled Commercial Banks (SCBs). Despite its massive share, the cumulative average growth rate (CAGR) for the amount of credit disbursed by Public-sector banks has declined drastically from 21.60% to 11.88% over the past decade (fig 2). The private-sector banks have grown significantly in the same period, with their CAGR increasing from 8.45% to 17.18%. According to CRISIL’s ratings in 2020, all the top five banks were privately owned, while 3 of the worst five banks belonged to the Public-sector.

Fig. 2 Amount of credit disbursed and its CAGR for Public and Private sector banks (Authors’ compilation)

A good Credit-to-Deposit (C-D) ratio helps deal with issues related to capital adequacy that a bank might be facing. The C-D Ratio for Public-sector banks has been declining along with a drop in the overall credit growth rate. On the contrary, the C-D Ratio for Private-sector banks shows an upward trend driven by a healthy disbursed credit growth rate. In 2016-17, the C-D Ratio for both Public and Private-sector banks dipped considerably following the demonetization, but it had a more adverse impact on Public-sector banks, as shown in Fig 3. Consequently, the Public-sector banks have been struggling to recover from it. This situation is worsened by the increase in non-performing assets (NPAs), especially in the priority sector.

Fig. 3 Amount of deposits and C-D Ratio for Public and Private sector banks (Authors’ compilation)

3. NPAs in Priority Sector Lending (PSL)

The overall share of NPAs in Priority Sector Lending (PSL) has been increasing, indicating the poor state of the banks’ asset quality. NPAs in PSL have increased by more than 20% since 2016. More than 40% of the PSL is diverted into Agriculture, Allied activities by means of agricultural credit provided through KCC, input subsidies, among others, and it has witnessed the steepest rise in NPAs. This finding hints at an unhealthy dependence among farmers on subsidies and loan waivers which provides short-term relief but is not fiscally sustainable in the long run. On the other hand, MSMEs and MFIs, and other PSL have performed better in terms of NPAs. Although demonetization severely crippled the MSME sector and microfinance, both these sectors have bounced back since and lowered their share of NPAs as shown in Fig 4. It is an interesting finding, which indicates that investment in privately run businesses can, in fact, be more profitable and help lower NPAs as well.

Fig. 4 Priority Sector Lending in sub-sectors and percentage of their respective NPAs (Authors’ compilation)

4. Budgetary Provisions FY 2021-22

Govt. has taken significant steps this year towards disinvestment and public-sector asset monetization in its announcement of Budget FY 2021-22. This year the Govt. has set a lofty target of INR 1.75 lakh crores disinvestment, considering the fact that last year the disinvestment target was over INR 2.1 lakh crores, out of which merely INR 19,500 crores (9.28%) crore was actually divested through minority stake sale in Central Public-Sector Enterprises (CPSEs) and share buybacks.

Hence, one of the Govt.’s major initiatives is to move all toxic loans from the banking sector into a consolidated ‘bad bank’. During the budgetory speech, it was said that this ‘bad bank’ will buy the toxic loans initially at a lower price and focus on recovering the money through specialized agencies such as Asset Management Companies (AMCs) and Asset Recovery Companies (ARCs). The ‘bad bank’ will likely be a mixed entity that includes the government, private investors, and the banks themselves. Govt. has also decided to privatize two Public-sector banks by the end of this financial year. As a remedial measure during the pandemic, the Stressed Advances Ratio (Gross NPAs & Restructured Standard Advances) of SCBs have been reduced by RBI. through asset classification relief provided during COVID-19.

It can be argued that moving bad loans to a separate ‘bad bank’ will help struggling banks, as they will only be left with pristine good loans. Consequently, external investors will be able to see the real money-making opportunity available in these banks. Simultaneously, relaxation of compliances for foreign investors and increasing the share of FDI up to 74% will also help boost investment. However, there are some reservations regarding the budgetary provisions, which need to be explored.

First, the proposed ‘bad bank’ will be buying the bad debts initially for about 20% of the total amount, while the rest 80% will be paid once the loans have been recovered completely. However, there might be a possibility wherein toxic loans may not be fully recovered by the AMCs and ARCs, as predicted. In that case, the issue of NPAs may well be further aggravated. Secondly, the inherent bureaucratic structure of the ‘bad bank’ may hinder the loan recovery process. Lastly, previous disinvestment targets achievement was not very encouraging and has been abysmally low (e.g., 9.28% in FY 2019-20) mostly due to a lack of intent and implementation on the part of the Govt. Hence, a better alternative to this ‘bad bank’ could be regulated and managed by apex bank i. e. Reserve Bank of India (RBI). Although banking stocks & other related financial secuities’s valuation have surged after the budget announcements, which is a good sign for the economy to bounce back, it is still too early to comment on whether this growing trend is maintained over a more extended period or not?

5. Way Forward

In order to solve the chronic NPA crisis, several initiatives have been already taken by the banking sector regulators in close coordination with the Government of India, who is the legislative authority of the country besides being owner of the Public Sector Banks. The schemes taken include: 5/25 infrastructure financing scheme (2014), Private Asset Reconstruction Companies under the SARFAESI Act (2014), Strategic Debt Restructuring (2015), INDRADHANUSH (2015), Asset Quality Review (2015), Insolvency and Bankruptcy Code (2016), Sustainable Structuring of Stressed Assets (2016), Amendments to the Banking Regulation Act and Recapitalization of the Public Sector Banks from time to time. Empirical studies have indicated that both the aggregate demand (macroeconomic) and bank credit (microeconomic) routes have a significant contribution to the huge piling of stressed assets.

In our analysis, though substantial steps have been taken to provide a robust bankruptcy regime from 2016 onwards and adequate recapitalization of the PSBs, the burning concern of the transfer of stressed assets from the bank’s financial statements have not been satisfactorily dealt with. It may be noted here that not only bankruptcy regime is still in its early days and needs the support of all stakeholders involved; but also providing capital support to banks may be counter-fruitful and may give only a temporary relief to the stressed balance sheet of these banks.

The process for the creation of Asset Reconstructions Companies began post the promulgation of SARFAESI Act. However, due to the decentralized nature of the process and scaling issues, ARCs could not accelerate the resolution of the task at hand. Hence, a centralized approach as announced in the Union Budget 2021-22 and recent creation of National Asset Reconstruction Company Limited (NARCL) with government supported security receipts of INR 30,600 crore seems to be the step in the right direction. Also, the setting up of the India Debt Resolution Company Limited (IDRCL) would provide a supporting role to NARCL for efficient asset management with the aid of market professionals and turnaround experts. Public Asset Management Companies in countries like Sweden, Korea, Ireland, Spain, Slovenia, etc. have proven track record in solving the twin balance sheet problem emanating from the NPA crisis. However, structural impediments in the establishment of both NARCL and IDRCL viz. governance structure, professional management, asset price valuations and transfer prices of assets need to be looked into for the effective execution of the government mandate.

As is evident from the above discussion, a multi-pronged approach needs to be adopted to ensure the revival of the Indian banking sector. Performance of the AMCs and ARCs should be closely monitored, and these organizations could take assistance from RBI when required to ensure optimum recovery of the transferred NPAs. Public-sector banks’ disinvestment is a welcome move since it provides an opportunity for Public-sector banks to learn and adopt best practices from the Private-sector banks that have been performing better. Priority sector lending, especially in the Agriculture and Allied activities sector, need to be reduced gradually in a phased manner for long-term fiscal sustainability. Accordingly, a shift from subsidies and loan waivers to capital investment could provide a better return on investment for the banking sector and help improve farmers’ income.

As per the ‘Doing Business’ 2020 report by World Bank, India jumped 14 places to the 63rd position on the ease of doing business ranking, which is a step in the right direction. Notably, India has improved its rank by 79 positions in the past five years (2014-19). In summary, the Govt. has shown intent to make the right decisions through its budget announcements for FY 2021-22. However, its implementation will have to be examined in order to gauge the actual impact on the banking and priority sectors in the long run.

By Mr. A. Pal, Dr. P.K. Singh & Mr. S. Das; ARF group Members, CRDIST, IIT Kharagpur

(Write to us at ANIRBAN.PAL2018@IITKGP.AC.IN for this blog related views & suggestions)