Charan Singh: Why are NPAs higher in public sector banks?--By Sri Charan singh
-Business standard 20th May 2014
Social sector obligations are only part of the problem; the extreme inefficiencies in credit and recovery mechanisms remain the bigger issues, especially when compared with private sector competitors
Charan Singh
May 19, 2014
In its recent report on governance in bank boards, P J Nayak, current head of Morgan Stanley India who headed the Reserve Bank of India (RBI)-appointed committee, pointed to the urgent need for the government to remove discriminatory external shackles imposed on public sector banks (PSBs), so that these banks can compete fairly with their private peers. This, in fact, is the general refrain from PSBs. They generally ascribe their burgeoning non-performing assets (NPAs) to their vulnerability to political pressures to lend to certain segments of the economy - known as "priority sector" lending - to fulfil social responsibilities. However, higher NPAs have been recorded in many sectors, including the priority sector, and the major stressed sectors are infrastructure, iron and steel, textiles, aviation and mining.
In a slowing economy, it is natural to assume that NPAs will increase. But in November 2013, K C Chakrabarty, then RBI deputy governor, had observed that the primary cause of rising NPAs was not the global slowdown but deficiencies in the credit and recovery mechanism. In fact, there could still be another factor: the procedure followed in extending and monitoring credit, for which there are significant differences in the approach of PSBs and private sector banks. This difference in approach can be easily identified if a common commodity is considered as an example: tractor financing where, anecdotally, NPAs in PSBs was nearly 50 per cent a few years ago.
In tractor financing, according to industry sources, private sector banks and non-banking finance companies (NBFCs) account for 60 per cent, while PSBs' share has shrunk to 10 per cent from nearly 50 per cent a few years ago. Private financial institutions that are at the forefront of tractor financing, are HDFC, Kotak Mahindra, and ICICI among the banks, and Mahindra & Mahindra, L&T, Tata Capital, and Cholamandalam among the NBFCs. Their NPAs are negligible. The interest rate ranges between 12 and 20 per cent for such loans which are generally less than four years and of amounts less than Rs 4 lakh. The instalments are made on mutual agreement, either on monthly or crop-pattern basis, and are collected by agents from the homes of the borrowers, against receipts delivered through hand-held devices. The employees of the lending institutions are present in the premises of tractor dealers and offer a commission of one per cent as an incentive to facilitate the loan for the company. The Know Your Customer (KYC) norms are generally very simple but for security purposes, the borrower provides three blank cheques on a returnable basis and two references. The loan is extended after extensive field inspection followed by a telephonic check made by the zonal or regional office.
Each of the private sector lenders has a risk control unit and there is also a third-party review that randomly checks the credentials of the borrower. The maximum amount of the loan is 75 per cent of the value of tractor to ensure that the borrower has a monetary stake in the purchase. Despite the elaborate arrangement, the loan is sanctioned within three working days. The tractor is hypothecated and the RC book is stamped. The recovery procedure is focused and sometimes, the recovery amount is enhanced, especially around harvest time.
In sharp contrast, PSBs strictly follow KYC norms and the borrower has to visit the branch office of the bank a number of times to avail of the loan. The rate of interest is lower than private sector and ranges between 10 and 15 per cent, the period of loan is higher and ranges between seven and nine years, and amount of instalments is lower and generally payable on a monthly basis. In most cases, the cost of commission offered to the employee of the lending institution ranges from five to seven per cent of the value of the loan. The process is slow and takes a few weeks for the loan to be realised.
In general, PSBs demand hypothecation of six to eight acres of land before extending the loan. In some cases, the same land gets hypothecated multiple times and the value of the same land for hypothecation is priced differently at, say, Rs 1 lakh and sometimes at Rs 50,000 per acre. There have been anecdotes in PSBs of the loan being collected from the bank but not the tractor from the agency. The verification process of the loan application is not robust and neither is the recovery; after the loan is dispensed there is no follow-up and no recovery mechanism. Unlike the private sector, PSBs are reluctant to repossess the tractor, often for political reasons.
As this brief comparative study suggests, PSBs urgently need to address attitudinal problems to tackle the issue of rising NPAs. More efficient borrower screening, credit appraisal and post-disbursement supervision would go a long way towards improving the commercial performance of these banks.
In a slowing economy, it is natural to assume that NPAs will increase. But in November 2013, K C Chakrabarty, then RBI deputy governor, had observed that the primary cause of rising NPAs was not the global slowdown but deficiencies in the credit and recovery mechanism. In fact, there could still be another factor: the procedure followed in extending and monitoring credit, for which there are significant differences in the approach of PSBs and private sector banks. This difference in approach can be easily identified if a common commodity is considered as an example: tractor financing where, anecdotally, NPAs in PSBs was nearly 50 per cent a few years ago.
In tractor financing, according to industry sources, private sector banks and non-banking finance companies (NBFCs) account for 60 per cent, while PSBs' share has shrunk to 10 per cent from nearly 50 per cent a few years ago. Private financial institutions that are at the forefront of tractor financing, are HDFC, Kotak Mahindra, and ICICI among the banks, and Mahindra & Mahindra, L&T, Tata Capital, and Cholamandalam among the NBFCs. Their NPAs are negligible. The interest rate ranges between 12 and 20 per cent for such loans which are generally less than four years and of amounts less than Rs 4 lakh. The instalments are made on mutual agreement, either on monthly or crop-pattern basis, and are collected by agents from the homes of the borrowers, against receipts delivered through hand-held devices. The employees of the lending institutions are present in the premises of tractor dealers and offer a commission of one per cent as an incentive to facilitate the loan for the company. The Know Your Customer (KYC) norms are generally very simple but for security purposes, the borrower provides three blank cheques on a returnable basis and two references. The loan is extended after extensive field inspection followed by a telephonic check made by the zonal or regional office.
Each of the private sector lenders has a risk control unit and there is also a third-party review that randomly checks the credentials of the borrower. The maximum amount of the loan is 75 per cent of the value of tractor to ensure that the borrower has a monetary stake in the purchase. Despite the elaborate arrangement, the loan is sanctioned within three working days. The tractor is hypothecated and the RC book is stamped. The recovery procedure is focused and sometimes, the recovery amount is enhanced, especially around harvest time.
In sharp contrast, PSBs strictly follow KYC norms and the borrower has to visit the branch office of the bank a number of times to avail of the loan. The rate of interest is lower than private sector and ranges between 10 and 15 per cent, the period of loan is higher and ranges between seven and nine years, and amount of instalments is lower and generally payable on a monthly basis. In most cases, the cost of commission offered to the employee of the lending institution ranges from five to seven per cent of the value of the loan. The process is slow and takes a few weeks for the loan to be realised.
In general, PSBs demand hypothecation of six to eight acres of land before extending the loan. In some cases, the same land gets hypothecated multiple times and the value of the same land for hypothecation is priced differently at, say, Rs 1 lakh and sometimes at Rs 50,000 per acre. There have been anecdotes in PSBs of the loan being collected from the bank but not the tractor from the agency. The verification process of the loan application is not robust and neither is the recovery; after the loan is dispensed there is no follow-up and no recovery mechanism. Unlike the private sector, PSBs are reluctant to repossess the tractor, often for political reasons.
As this brief comparative study suggests, PSBs urgently need to address attitudinal problems to tackle the issue of rising NPAs. More efficient borrower screening, credit appraisal and post-disbursement supervision would go a long way towards improving the commercial performance of these banks.
Charan Singh is RBI Chair Professor of Economics, IIM Bangalore. The author has been a commercial banker and with the RBI for more than two decades. These views are personal and based on extensive discussions with tractor dealers and commercial banker
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