The state of Indian banking sector
Four of India’s top bankers discuss the toughest challenge the banking system is confronting—rising non-performing assets
Mumbai: Four of India’s top bankers gathered for the sixth edition of Mint’s annual banking conclave on 27 February in Mumbai to discuss the toughest challenge the banking system is confronting—rising non-performing assets (NPAs).Pratip Chaudhuri, chairman of State Bank of India; Chanda Kochhar, managing director and chief executive officer of ICICI Bank Ltd; Aditya Puri, managing director of HDFC Bank Ltd; and Pramit Jhaveri, chief executive officer of Citibank India, were of the opinion that accelerating the pace of economic growth and project implementation hold the key for a resolution of the problem. Tamal Bandyopadhyay, deputy managing editor of Mint, moderated the discussion. Edited excerpts:
Bandyopadhyay: Bad assets of the banking system have been growing. In past one year till December, the quantum of gross NPAs has grown 43% and net NPAs by at least 55% while credit growth has been just 15%. Why is this happening? Inefficiency of the banking system or economic slowdown?
Puri: When there is a slowdown, there will be some increase in NPAs. If you have issues in providing raw material, last-mile clearances and mining, etc. the bankers end up holding the baby but they are not the cause for it. If you have a coal and a power plant, you should be able to get them going and it’s not the job of the bankers. I guess we could have had better monitoring, but that seems to be in hindsight. I also like to emphasize that not every NPA is a loss asset and the level of NPAs is totally manageable by the banking system. We are safe, sound and healthy.
Jhaveri: We had a very significant problem in the area of consumer finance in 2007 and 2008 and it’s difficult to blame any of the factors for that other than ourselves. That was the time when liquidity was plenty in the country and consumer finance was something that a lot of banks were doing aggressively. We made some mistakes in targeting markets, lowering underwriting standards in the quest for market share and growth and the credit infrastructure at the time was not as good as today. We paid a very high price.
We learnt a lot from that and we have started applying those lessons and today the levels of NPA losses are well within control. At the end of the day, the banking industry is going to be impacted when you have an economic slowdown, extraneous factors, scams and certain other things like ban on mining in a state.
Kochhar: The fact is NPAs are rising. If you have a situation where economic growth slows down from 9% to 5% over 24 months and interest rates and inflation are still high and decision-making is not as fast as it ought to be to get the project completed up to the last mile, you cannot say that the quality of assets will not be affected. But is the level of NPAs or restructured assets something that can create a crisis for the sector? Clearly, no. The net NPA is at a comfortable level and as far as the restructured assets are concerned, the quantum looks large but we have to remember that in India the experience in turning around restructured assets has actually been pretty good.
In a growth economy, when you set up assets, if there are issues regarding implementation like getting the last-mile raw material, the coal and mining approvals, environmental clearances, the cash flows get delayed. So, you have to handhold onto those assets for a few years but as the projects get completed the cash flows start because there is always an underlying demand for the products; the restructured assets actually get worked out on account of the growth of the economy. We have to take the right steps to get the economic momentum back.
Chaudhuri: The sector which is struggling the most is the manufacturing sector. If you look at the growth, GDP (gross domestic product) is growing at 5%-5.5% whereas industrial production growth is just 0.5%. So, the banks which have lent to this sector— the real sector—will have a larger tranche of NPAs. This is understandable though not justifiable.
Manufacturing sector is bearing the brunt because it has huge linkages and we were slightly naïve in believing that whatever schedules have been given for commercial production will be adhered to. Now, if there is no fuel linkage, the plant does not come up, there is a power cut. In Andhra Pradesh and Tamil Nadu, relatively highly industrialized states, there is 40% power cuts which forces you to buy expensive power and this takes you deeper into debt.
Secondly, we possibly also did not recognize that there was long-term funding from short-term sources. Look at FCCBs (foreign currency convertible bonds) which were issued in the hope that two-three years down the line, the issuer will get funding at low cost; and at the end of the second year or third year the debt gets converted into equity. But, the kind of pricing that the promoters wanted never materialized. So, instead of becoming an equity, the FCCBs became a debt. Seven out of 10 accounts that have been restructured or have run into problem had FCCBs which could not be rolled over. This is something which we did not experience in 1997-98.
We also did not anticipate that one-year delay in the commercial production would make an account NPA. Today, we are much wiser. If a hotel project comes and proposes to repay in nine or 10 years, we ask them to recalculate their arithmetic and come back with a plan for 14 years.
The current NPA picture is holding a mirror to our face that there are serious problems in the economy and unless we get back our growth, and particularly the investment cycle, this problem will continue to haunt us. But, at the same time, I do not wish to project a picture of doom.
In our case, the gross NPA is 5.5% but net is at 2.6%. So, 2.9% is provided for and we still have significant surplus left with us after paying for NPAs.
One interesting thing I will like to bring to notice is that in the last five years, if anybody had invested in the lowest performing banking stock, it has given better returns than a Nifty stock. In spite of NPAs and the problems that come with NPAs, the earnings of banks have been substantial and possibly better than all other sectors.
Bandyopadhyay: Till recently you had been harping on the problems of the agriculture sector and now you’re talking of manufacturing....
Chaudhuri: Manufacturing grabs the headlines. If you look at a bank, lending to agriculture, home loan, consumption loans, car loans, etc. at best can constitute 40% of its portfolio. So, you have to lend to manufacturing. In agriculture lending, there are different ways like waiver, rescheduling, etc. and because they are not big-ticket loans, they can be absorbed relatively easily and they do not make headlines but a Rs.2,000 crore account going into stress makes big news.
Nation building
Bandyopadhyay: HDFC Bank has been growing at 30% every quarter and still its NPAs are negligible. This is possibly because it does not lend to many sectors. Actually the nation-building is being done by Chaudhuri’s bank and Puri is happy making sure that returns to investors are high.
Puri: Your questions contradict themselves. If I am growing at 30%, I must be lending to somebody. As far as nation-building is concerned, I am the largest lender in consumer finance. If you go into the interior of the country, some of the products that have done the maximum for us are two-wheelers, loan against gold, light commercial vehicles, tractors. About 60% of our branches are in semi-urban and rural areas and we have given sustainable livelihood to 1.5 million families and brought them above poverty line. If 20 of us did this, we wouldn’t have poverty in this country.
I take strong objection to your allegation that we are not involved in nation-building. We are the most prominent bank on the lending side where 70% of India lives. The fact is that in a growing economy like India where demand exceeds supply—and it will soon work out even in commercial bank licences—I don’t think we have to take extra risks. For the record, we have lent to infrastructure.
Bandyopahdyay: Aviation? The core sector?
Puri: You know I am not supposed to lend where I won’t get my money back. In a commercial organization, there are multiple constituents—keeping my job, protecting the interest of investors and the depositors…But you have raised an important point—I don’t think bankers are responsible for aviation not taking off. I think the country needs to strongly introspect as to what is causing the banking problem; so don’t put everything at the doors of the bankers just like interest rates and the Reserve Bank of India are not fully responsible for turning around the economy.
I lend to a project where power is being produced.
Bandyopadhyay: Essentially Puri is saying that banks are getting into certain areas which are not paying. Do you agree with him?
Chaudhuri: We can’t quarrel with success and every bank has its own philosophy, ethos and culture…No bank can become a look-alike of another bank. In terms of where would one lend and on what policy and security is for every bank to decide on. Every bank has to find its own place under the sun.
Why public sector banks suffer more?
Bandyopadhyay : Why are public sector banks more affected when it comes to piling up of bad assets or restructured loans? Is it political pressure or inefficiency in the lending process?
Chaudhuri: I should not generalize on behalf of all public sector banks as there are wide variations among them. The accounts which have gone into restructuring have been existing for past 20 years. If the due diligence was good in initial years, what happened in the last 10 years?
On political interference, I can say that at SBI we never get any direction from the government to lend to any undesirable account. There is enough mechanism to stand up even if such requests are made.
The problem is that PSU (public sector undertaking) banks have a higher lending rate. When you have a higher lending rate, the best customers do not come to you. So, you go in search of second best or third best customer, where the probability of delinquency is high.
When the economy was growing well, loans given to even the second level or third level companies, say textile or power companies, would not get bad. But in bad time, only the most efficient and well-capitalized companies can survive and others hit the bottom. That is what has happened.
Finally, PSU banks have been traditionally lending to state utilities and companies that feed state utilities. Today, the difficult fiscal positions of many of the state utilities, particularly that of discoms (distribution companies in the power sector), is an issue. Those PSU banks which have higher exposure to such companies have a higher share of troubled assets.
Bandyopadhyay: Are public sector banks charging higher lending rate than private banks?
Kochchar: I think the base rate of all three banks (SBI, ICICI Bank and HDFC Bank) are at the same level. But it varies product by product.
On the question of PSU banks having higher NPAs, I would not like to generalize it. Every bank has a different experience as far as non-performing assets are concerned. These are based on two or three factors. One is the composition of assets and the second, of course, some amount of underwriting or credit policies; and third is monitoring.
When we talk about the composition of assets, the way the economy has moved, the retail business is actually showing much more stable performance as far as NPA levels are concerned, whereas the SME (small and medium enterprises) and agri sector have been not doing so well. So, those banks that have fair mix across these segments, have a manageable level of NPAs and those which have higher level of SME and agri loans have higher level of NPAs.
Also, the way underwriting is done makes a difference. This is not because the underwriting process of one bank is wrong and other bank is right; there are so many parameters upon which decisions are taken. As the real facts pan out, you will know which assumptions were right. For example, we have many power projects under implementation but we don’t see a big risk in our power portfolio because we are not funding any power project based on gas, for the simple reason that we were never clear what the gas allocation policy would be. The third aspect is how proactive is your monitoring and your ability to recover from an account that is in difficulty.
Jhaveri: NPAs are only one thing to gauge the health of a bank. There are several factors such as the capital ratios, profitability and liquidity. You have to look at the combination of these factors. NPAs alone don’t necessarily challenge the health of the industry. If you go back to the global financial crisis, when the global institutions had huge levels of credit losses, they also had leverage levels incredibly high and their capitalization was very low. You need to put all those factors in context and take a larger view; I don’t think you should just focus on NPAs.
Bandyopadhyay: Roughly about 8% of total loans of Indian banks have been restructured as of now. Will we see more restructuring? Or, are banks reluctant to do so with the rise in provision requirement for such loans?
Chaudhuri: Restructuring is done everywhere. The 2.75% provisioning on restructuring is reasonably okay, because tomorrow if the restructured asset come back to shape, this provisioning can be written back. It also depends on to what extent the equity markets perform and FCCBs can be rolled over. But, time and again, we have tried to be optimistic and we have been proved wrong. Restructured assets follow the pattern of IIP numbers. If IIP numbers are robust, then the restructuring problems will abate
Kochhar: Clearly, there will be additions to restructured assets. I don’t think we have reached a situation in the economy where we can say there will be no more additions to this. The decision to add something to restructured assets is not just based on the guidelines but on whether you see a long-term viability in the project or not.
If you believe that the project or the company has lost its long-term viability, you should classify it as NPAs. If you believe that the project has long-term viability but has temporary issues and it needs handholding, then you take a decision to classify it as restructured asset, because you believe that with the growth in the economy, the project will grow out of restructuring and turn to a standard asset. But given the state where we are currently, where many projects are delayed and are facing cost and time overruns, there is still going to be additions to restructured assets in the banking sector. But most of these restructured assets will come back as standard assets as the economy comes back on growth path.
Jhaveri: If it is something which is temporary, there is a reason for optimism. It all depends on the factors that led to that particular asset becoming a restructured one.
Puri: There will be stress and constraints when an economy is in transition. If that’s a cause of concern that it will go bad then you only have to look into US. They still haven’t provided for their mortgage. So, if we were to follow international standards, we won’t be looking like this.
Let me make it very clear that Indian banks, on a comparative basis, would be role models. But there seems to be an impression that the bankers are irresponsible in restructuring. That’s not true. The economy was growing at 9% and now at 5%, you need three more years for the cash flow generation.
There’s nothing wrong with restructuring. To overstress on restructuring in an economy that is not only transitioning, but has other issues in terms of political governance, is not correct. We are short of power in this country—can you really think a power plant will go bad in the long run? If power plants go bad, the country will go bad. Let’s not make it a banking problem; if you can’t solve that, the whole country has a problem. We are growing 5.5% now, by next year we should be growing at 6%. We are sorting out the problems. If it reaches 6-7%, then most of what we are discussing now will be history.
Bandyopadhyay: A rating agency has recently said that Indian banks are sitting on wide asset-liability mismatches. Most of the deposits are of one-year maturity but the loans are of long-term maturity.
Puri: The rating agency should have a better understanding. Yes, obviously a large proportion of our deposits are for one year but we also have 45% of the deposits as current and savings account. I think it could be better if they would understand the actual concentration. And, I am not making an apology or giving anybody any explanation; I don’t have 45% long-term assets. In addition, 23% is the SLR (statutory liquidity ratio—government bond holding) which is liquid.
Chaudhuri: Globally banks borrow short and lend long. Speaking about my bank, there is Rs.1 lakh crore of tier I capital, Rs.25,000 crore of tier-II, which has an average life of 10-15 years, and we are lending for working capital.
Well capitalized banking system
Kochhar: We all have to monitor the bad loan situation but there is light at the end of the tunnel. We all talk about asset-liability mismatches but let’s look at various other factors. Everything that the global regulatory system is debating today about what they should impose on their banks already exists for Indian banks.
Our banks do not operate at high-leverage levels that the global banks have been doing. The Indian banks have had a very high level of capital adequacy ratio; besides the quality of tier-I capital adequacy has always been equity capital and not various other forms of capital which the global banks are now struggling to raise.
We have always maintained high levels of liquidity in the form of SLR, CRR (cash reserve ratio) while the global banks are struggling to define the liquidity ratios. We actually have announced the Basel III guidelines which are stringent and little bit more ahead of many other countries, when larger countries are still debating the guidelines.
Puri: Also, the dependence of the Indian banks on money market is negligible. About 95% of our deposits are customer deposits or capital.
Kochhar: In 2008, when the crisis started worldwide the origin of the crisis was global financial sector, which in a way caused some pain in the real sector. In India, the banking sector provided all the strength to the real sector to come out of the crisis.
Jhaveri: As far as asset-liability mismatches are concerned, you are talking about very large banking institutions which have been around for a very long time. I don’t think they would be run in such a condition where there will be a very large asset-liability mismatches. Yes, as Aditya said, our average deposit may be of a short tenure but you got to look at over a period of time what are the core deposits that reside with the bank. I don’t think there is a significant asset-liability mismatch in the Indian banking system.
But I do believe that there is one area for financial sector reform in India—it is the development of the corporate bond market. The only avenue that funds everything in India—whether it’s development, consumption, manufacturing, or agriculture—is the banking system. There’s an over-dependence on the banking system and we need corporate bond market.
Is the worst behind
Bandyopadhyay: Is the worst behind us?
Puri: You tell me what the GDP will be and I will tell you whether the worst is behind us. If the GDP growth is 6%, worst is behind us; if you don’t get your act together, don’t expect much. The banks are only a mirror.
Jhaveri: If you look at the last six and seven months in terms of the policy and reform initiative by the government, there’s certainly room for optimism. Having said that, when you look at the real economy, there’s much more work to do. The decisions made in last few months have triggered foreign capital flow. I don’t think domestic capital has yet got those catalysts that can lead the corporate India into a decision-making mode. This is what I would be looking for in the next few months that will determine whether 5% is going to be 6% or higher. There’s room for optimism but we have to wait and watch.
Chaudhuri: Things are looking up but we should not wish the problems away. We have hope in the future but at the same time we must build defences for a possible not-so-optimistic scenario. I agree with Mr Puri that it would be a function of the GDP growth and also a function of the investment cycle because India is a high-saving economy— no matter what happens, 30% of the GDP comes back as savings. And the banks enjoy such an amount of confidence with the general public that the flow of funds to the banking system continues to remain unabated.
Kochhar: Whether there will be pain or not, or the rate of elevation of pain, will entirely depend on the rate of growth of our economy and the rate at which we can bring the investment cycle back. In a way, the pain in the banking sector, will move away or elevate only with a lag because if we take decisions today, like importing coal for the 20,000 MW (megawatt) power projects, it doesn’t mean that those projects will start paying interest today. Cash flow doesn’t get generated overnight.
Only if we decide on importing the coal today, we will have to make sure the logistics of importing the coal, the pricing, the tariff and then the coal comes and then the plant starts and then they start generating the cash flow. The uptick will also happen with a lag and today’s decision will not impact us positively tomorrow.
So, in the immediate term, there will be some challenges but in the medium term, we do have an economy that should grow from here.
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