The Banking Ordinance is no magic pill for ailing banks

Recently, the government promulgated the Banking Regulation(Amendment) Ordinance, 2017, to tackle the huge amount of bad loans that have accumulated in the Indian banking system in general and the government owned public sector banks in particular. Bad loans are essentially loans in which the repayment from a borrower has been due for 90 days or more.

This Ordinance is now being looked at the magic pill which will cure the problems of Indian banks. Will it?

The Ordinance essentially gives power to the Reserve Bank of India(RBI) to give directions to banks for the resolutions of bad loans from time to time. It also allows the Indian central bank to appoint committees or authorities to advise banks on resolution of stressed assets.

The basic assumption that the Ordinance seems to make is that the RBI knows more about banking than the banks themselves. This doesn’t make much sense for the simple reason that if the RBI was better at banking than the banks themselves, it would have been able to identify the start of the bad loans problem as far back as 2011, which it didn’t.

Over and above this, this is not the first time that Indian banks have landed in trouble because of bad loans. They had landed up in a similar situation in the early 1980s and the early 2000s as well, and the RBI hadn’t been able to do much about it.

In fact, at the level of banks, many banks have been more interested in postponing the recognition of the problem of bad loans. This basically means they haven’t been recognising bad loans as bad loans. One way of doing this is by restructuring the loan and allowing the borrower a moratorium during which he does not have to repay the principal amount of the loan. In some cases, even the interest need not be paid. In some other cases, the tenure of the loan has been increased. In many cases this simply means just pushing the can down the road by not recognising a bad loan as a bad loan.

Why have banks been doing this? The Economic Survey gives us multiple reasons for the same. Large debtors have borrowed from many banks and these banks need to coordinate among themselves, and that hasn’t happened. At public sector banks recognising a bad loan as a bad loan and writing it off, can attract the attention of the investigative agencies.

Also, no public sector banker in his right mind would want to negotiate a settlement with the borrower who may not be able to repay the entire loan, but he may be in a position to repay a part of the loan. As the Economic Survey points out: “If PSU banks grant large debt reductions, this could attract the attention of the investigative agencies”. What makes this even more difficult is the fact that some of defaulters have been regular defaulters over the decades, and who are close to politicians across parties.

Hence, bankers have just been happy restructuring a loan and pushing the can down the road.

Over and above this, writing off bad loans once they haven’t been repaid for a while, leads to the banks needing more capital to continue to be in business. In case of public sector banks this means the government having to allocate more money towards recapitalisation of banks. There is a limit to that as well.

Also, a bigger problem which the Economic Survey does not talk about is the fact that the rate of recovery of bad loans has gone down dramatically over the years. In 2013-2014, the rate of recovery was at 18.8 per cent. By 2015-2016, this had fallen to 10.3 per cent. Hence, banks were only recovering around Rs 10 out of the every Rs 100 of bad loans defaulted on by borrowers. This is clear reflection of the weak institutional mechanisms in India, which cannot change overnight.

Also, many of the companies that have taken on large loans are no longer in a position to repay. As the Economic Survey points out: “Cash flows in the large stressed companies have been deteriorating over the past few years, to the point where debt reductions of more than 50 percent will often be needed to restore viability. The only alternative would be to convert debt to equity, take over the companies, and then sell them at a loss.”

The first problem here will be that many businessmen are very close to politicians.
Hence taking over companies won’t be easy. Over and above this, it will require the government and the public sector banks, working with the mindset of a profit motive, like a private equity or a venture capital fund. And that is easier said than done.

The column originally appeared in the Daily News and Analysis on May 22, 2017.

Mr Subramanian, Lower Interest Rates Do Not Always Lead to More Bank Loans

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“Lower interest rates lead to higher lending,” is something that most economists firmly believe in. The beliefs of Arvind Subramanian, the chief economic adviser to the ministry of finance, are not an exception to this rule.

Hence, not surprisingly in a lecture a few days back he came out all guns blazing against the Reserve Bank of India(RBI) for not cutting the repo rate. Repo rate is the rate at which RBI lends to banks and acts as a sort of a benchmark to the interest rates that banks pay for their deposits and in turn charge on their loan. We say sort of a benchmark here because there are other factors which go into deciding what rate of interest that banks charge on their loans.

Subramanian wants the RBI to cut the repo rate further from its current level of 6.25 per cent. As he said: “Inflation pressures are easing considerably… the inflation outlook is benign because of a number of economic developments… Against this background, most reasonable economists would say that the economy needs all the macroeconomic policy support it can get: instead, both fiscal policy and monetary policy remain tight.

The point here being that current inflation is under control and from the looks of it, future inflation should also be under control. And given this, the RBI must cut its repo rate. The RBI last cut the repo rate in October 2016. And as and when it cuts the rate further, the hope is that the banks will cut their lending rates. Only then will people and industries both borrow and spend more. This will give a flip to the economy. QED.
Subramanian’s point is well taken. Nevertheless, does it make sense? We will deviate a little here before we arrive at the answer.

The RBI Monetary Policy Report released in early April 2017 points out that the decline in the one-year marginal cost of funds based lending rates (MCLRs) of banks between April and October 2016 was just 15 basis points. This when the repo rate was cut by 50 basis points. Hence, even though the RBI cut its repo rate by 50 basis points, the banks cut their lending rates by just 15 basis points, a little under a one-third. One basis point is one hundredth of a percentage.

Post demonetisation “27 public sector banks have reduced their one-year median MCLR in the range of 50 to 105 bps, and 19 private sector banks have done so in the range of 25 to 148 bps.” This when the repo rate has not been cut at all. On an average the one year MCLRs of banks fell by 70 basis points to 8.6 per cent.

What has happened here? A cut in the repo rate barely makes any difference to the cost at which banks have already borrowed money to fund their loans. But demonetisation did. The share of the “low cost current account and savings account (CASA) deposits in aggregate deposits with the SCBs went up to 39.2 per cent (as on March 17, 2017) – an increase of 4.0 percentage points relative to the predemonetisation period”. This is because people deposited the demonetised notes into the banks and this money was credited against their accounts.

This basically meant that banks suddenly had access to cheaper deposits because of demonetisation. And this in turn led them to cut interest rates on their loans, despite no cut in the repo rate. The RBI’s repo rate continued to be at 6.25 per cent during the period.

A cut in lending rates is only one part of the equation. The bigger question has it led to higher borrowings? Are people and businesses borrowing more because lending rates are now lower than they were in the past? And this is where things become interesting.
The total deposits of banks between October 28, 2016 (before demonetisation) and December 30, 2016 (the last date to deposit demonetised currency into banks) went up by 6.41 per cent to Rs 10,568,17 crore. This was a huge jump during a period of two months. This sudden increase in liquidity led to banks cutting their deposit rates and then their lending rates.

Interestingly, the total deposits of banks have continued to remain stable and as of April 30, 2017, were at Rs 10,509,337 crore. This is a minor fall of 0.6 per cent since December 2016.

Between end October 2016 and end April 2017, only around 36 per cent of the incremental deposits raised by banks were loaned out. (We are looking at non-food credit here. The total bank loans that remain after we adjust for the loans that have been given to the Food Corporation of India and other state procurement agencies for the procurement of rice and wheat produced by farmers).

This means for every new deposit worth Rs 100, the bank loaned out just Rs 36, despite a cut in interest rates.

If we were to look the same ratio between end October 2015 and end April 2016, it projects a totally different picture. 116 per cent of the incremental deposits during the period were lent out. This means for every new deposit worth Rs 100, the bank loaned out Rs 116.  This means that deposits raised before the start of this period were also lent out.

Hence, a greater amount of lending happened at higher interest rates between October 2015 and April 2016. And this goes totally against Subramanian’s idea of the RBI needing to cut the repo rate. It also goes against the idea of banks lending more at lower interest rates.

Given this, low interest rates are only a part of the story. If that is not leading to higher lending, it doesn’t help in anyway. Lending isn’t happening due to various reasons, which we keep discussing. Demonetisation has only added to this issue.

Also, a fall in interest rates hurts those who depend on a regular income from fixed deposits to meet their expenditure. It also hurts those who are saving for their long-term goals. In both the cases, expenditure has to be cut down. In one case because enough regular income is not being generated and in another case in order to be able to save more to reach the investment goal. And this cut in spending hurts the overall economy. Interest rates are also about the saver and depositor.

We are yet to see a professional economist talk from this angle. To them it is always a case of garbage in garbage out i.e. lower interest rates lead to increased lending. This is simply because most professional economists these days get trained in the United States where the system is totally different and lower interest rates do lead to a higher borrowing by businesses and people.

But that doesn’t necessarily work in India. It is a totally different proposition here.

The column originally appeared in Equitymaster on May 15, 2017.

Six Months After Demonetisation Cash is King Again and Questions Still Remain

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On November 8, 2016, the prime minister Narendra Modi announced his government’s decision to demonetise Rs 500 and Rs 1,000 notes, to an unsuspecting nation. The decision came into effect from the midnight between November 8 and November 9, 2016, and suddenly rendered 86.4 per cent of the nation’s currency in circulation, useless.

It’s been six months since then and more than four months since December 30, 2016, the last date for depositing the demonetised Rs 500 an Rs 1,000 notes, into bank accounts. But even after this period as far as the government is concerned, a few basic points remain.

a) How much demonetised money finally made it into bank accounts? When demonetisation was first announced, this number was shared regularly. Nevertheless, the last announcement on this front from the Reserve Bank of India(RBI) came on December 13, 2016. As of December 10, 2016, Rs 12.44 lakh crore of demonetised currency had made it back into the banks.
Given that Rs 15.44 lakh crore worth of currency notes had been demonetised, nearly 80.6 per cent of the currency had found its way back into banks, nearly three weeks before the last date to deposit demonetised notes into bank accounts.
Neither the Reserve Bank nor the government has told the nation how much money eventually made it back into the banks. This is an important question and needs to be answered.

b) The initial idea behind demonetisation was to curb fake currency notes and eliminate black money.
As far as fake currency goes the minister of state for finance Arjun Ram Meghwal told the Lok Sabha in early February 2017 that the total number of fake notes deducted in the currency deposited into banks after demonetisation stood at 2.46 lakhs. This amounted to a total value of Rs 19.5 crore.
As mentioned earlier, the total value of demonetised notes had stood at Rs 15.44 lakh crore. Given this, the proportion of fake notes deducted is almost zero and can be ignored. Hence, as far as detecting and eliminating fake notes was concerned, demonetisation was a total flop.
How did it do as far as eliminating black money is concerned? The hope was that the black money held in the form of cash will not make it back into the banks, as people wouldn’t want to get caught by declaring it. But by December 10, 2016, more than four-fifth of the demonetised notes had already made it back into the banks. Since then the government and the RBI have not given out any fresh numbers. It’s surprising that it has been more than four months since December 30, 2016, and this number is still not out in the public domain.
Also, it is important to point out here: “High denomination notes are known to facilitate generation of black money. In this connection, it may be noted that while the total number of bank notes in circulation rose by 40% between 2011 and 2016, the increase in number of notes of Rs.500/- denomination was 76% and for Rs.1,000/- denomination was 109% during this period.”
If high denomination notes facilitate generation of black money, then why replace Rs 1,000 notes with Rs 2,000 notes. Given that a Rs 2,000 note is twice the value of a Rs 1,000 note, it makes black market transactions even more easier. It also makes storage of black money in the form of cash easier, given that it takes less space to hide the same amount of money.
Again, this is a basic disconnect in what the government planned to achieve through demonetisation and what it eventually did. No effort has been made to correct this disconnect.

c) The government has still not offered a good explanation of what prompted it to demonetise. There has been no similar decision taken by any other country in a stable financial situation like India currently is, in the modern era. The best that the government has done is blamed it on the RBI. As Meghwal told the Lok Sabha in early February 2017: “RBI held a meeting of its Central Board on November 8, 2016. The agenda of the meeting, inter-alia, included the item: “Memorandum on existing banknotes in the denomination of Rs 500 and Rs 1000 – Legal Tender Status.””
Anybody who has studied the history of the RBI would know that the RBI would never take such an extreme step without extreme pressure from the government.

d) Other than eliminating black money and fake currency notes through demonetisation, in the aftermath of demonetisation, the government wanted to promote cashless transactions. As Modi said in the November 2016 edition of themann ki baat radio programme: “The great task that the country wants to accomplish today is the realisation of our dream of a ‘Cashless Society’. It is true that a hundred percent cashless society is not possible. But why should India not make a beginning in creating a ‘less-cash society’? Once we embark on our journey to create a ‘less-cash society’, the goal of ‘cashless society’ will not remain very far.”

How are things looking on that front? Look at the following table. It shows the volume of digital transactions over the last few months.

Month Volume of digital transactions (in million)
Nov-16 671.5
Dec-16 957.5
Jan-17 870.4
Feb-17 763.0
Mar-17 893.9
Apr-17 843.5

Source: Reserve Bank of India

While digital transactions picked up in December, they have fallen since then. The total number of digital transactions in April 2017 is higher than it was in November 2016. Nevertheless, it is worth asking, whether this jump of 25 per cent was really worth the trouble of demonetisation.

e) Falling digital transactions since December 2016 tell us that cash as a mode of payment is back in the system. There is another way this can be shown. Between November 2016 and February 2017, banks barely gave out any home loans. During the period, the banks gave out home loans worth Rs 8,851 crore. In March 2017, they gave out total home loans of Rs 39,952 crore, which was 4.5 times the home loans given out in the previous four months. It also amounted to 35 per cent of the home loans given out during the course of 2016-2017.

A major reason why people weren’t taking on home loans between November 2016 and February 2017 was demonetisation. There simply wasn’t enough currency going around. With this, the real estate transactions came to a standstill because without currency it wasn’t possible to fulfil the black part of the real estate transaction. Those who owned homes (builders and investors) were not ready to sell homes, without being paid for a certain part of the price, in black.

By March 2017, nearly three-fourths of the demonetised currency was replaced. This basically means that by March 2017, there was enough currency in the financial system for the black part of the real estate transactions to start happening all over again. Also, the Rs 2,000 note makes this even more convenient.

To conclude, six months after the declaration of demonetisation it is safe to say that demonetisation has failed to achieve what it set out to achieve i.e. if it set out to achieve anything on the economic front.

The column originally appeared on Firstpost on May 9, 2017

Viral Acharya is Right About Re-privatising Public Sector Banks

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Late last week Viral Acharya, a deputy governor of the Reserve Bank of India (RBI), said: “Perhaps re-privatising some of the nationalised banks is an idea whose time has come … this would reduce the overall money government needs to inject as bank capital.”

Regular readers of the Diary would know that we have said several times in the past that public sector banks should be privatised and the government should get out of the banking business, which it is clearly inept at.

Of course, the question is why has Acharya used the term re-privatising rather than privatising. Indira Gandhi nationalised 14 private banks on July 19, 1969. These banks had deposits of Rs 50 crore or more and among them accounted for 90 per cent of the banking business in the country. The funny thing is that at the time this happened, the then RBI governor LK Jha had no clue about it.

As TCA Srinivasa Raghavan writes in Dialogue of the Deaf—The Government and the RBI: “Volume three of RBI’s official history says that on July 17 she [Indira Gandhi] asked LK Jha, the RBI governor to come over to Delhi. Jha thought he was being asked to discuss social control and he took with him a comprehensive note on the subject. When he offered it to Mrs Gandhi she told him ‘that he could keep the note on her table and go to the next room and help in drafting the legislation on nationalising the banks.’”

In 1980, six other private banks were nationalised. This time the recommendation came from the then RBI governor, IG Patel.

Now getting back to what Acharya said, re-privatising is something we have advocated in the past. And it makes sense at multiple levels. We now have nearly two decades of evidence that suggests that the new generation private sector banks which were first set up in the mid-1990s, are much more efficiently run than their public-sector counterparts. Yes, there have been cases like the Global Trust Bank, but on the whole private banks are better run than their public sector counterparts. Even the old generation private sector banks, which are very small, are reasonably well run.

Take the case of the bad loans situation that currently plagues the Indian banking sector in general and the public sector banks in particular. As on December 31, 2016, the total bad loans of the public sector banks (gross non-performing assets (NPAs)) had stood at around Rs 6.46 lakh crore.

For the private sector banks, the same number stood at Rs 86,124 crore. Of this, two banks, ICICI Bank and Axis Bank, accounted for bad loans of Rs 58,184 crore. Of course, given that public sector banks give out more loans, it is not surprising that their bad loans are more.

The total loans of public sector banks are 2.9 times the total loans of private sector banks. But their bad loans are 7.5 times that of private banks. If both these set of banks were equally well run, then the two ratios just referred to, wouldn’t have been different.

Between 2013-2014 and 2015-2016, the total net profit made by the public sector banks stood at Rs 56,567 crore and that of private banks stood at Rs 1,13,801 crore. This, even though public sector banks are significantly bigger than India’s private banks.

These data points tell us that India’s public sector banks are inefficiently run. And this inefficiency has cost the government a lot of money over the years. Between 2009 and March 2017, the government has had to invest close to Rs 1.5 lakh crore in these banks to keep recapitalising their capital, in order to keep them going.

Indeed, this is a lot of money and could have gone towards other worthy causes. The basic problem with public sector banks is political meddling. Every government has its favourite set of industrialists and this ultimately leads to the public sector banks and in the process the taxpayer, picking up the bill for this politician-businessman nexus.

As Acharya writes in a paper titled Is State Ownership in the Indian Banking Sector Desirable?: “One, state ownership creates severe moral hazard of directing bank lending for politically expedient goals and of bailouts when such lending goes bad. Second, state ownership restricts the ability of state-owned banks from raising arm’s length capital against state’s stake, strangling their growth and keeping these banks—and certainly their private capital base—smaller than it need be.”

What does this mean in simple English? The economist Alan Blinder in his book After the Music Stopped writes that the “central idea behind moral hazard is that people who are well insured against some risk are less likely to take pains (and incur costs) to avoid it.” Hence, managers of government owned banks know that if loans given to businessmen close to politicians go bad, the government will ultimately pick up the tab by recapitalising the public sector bank to an adequate extent. Hence, they go easy on giving loans to borrowers who are likely to default. Of course, there is always the threat of transfers, which works very well. This has happened for years at end.

Secondly, given that the government has to continue owning a certain proportion of shareholding in these banks, the banks cannot raise as much capital as they require. They have to continue to be dependent on the government for capital. And the government of course does not have an unlimited amount of cash. This limits the ability of the government owned banks to raise as much capital as they may require at any point of time.

So, what are the actual chances of the government re-privatising some of the public sector banks, as suggested by Acharya? Zero. While Acharya, I and others, might think that the basic problem with public sector banks is government ownership, politicians don’t think so. This comes from the belief that if you own banks then you can direct lending to areas that you want to. But this as we have seen comes with its own set of costs.

The column originally appeared on Equitymaster on May 3, 2017.

Bank Lending Down by Half in 2016-2017

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On April 6, 2017, the Reserve Bank of India(RBI) published the latest Monetary Policy Report. Buried on page 40 of the report is a very interesting data point which rather surprisingly hasn’t been splashed on the front pages of the pink papers as yet.

In 2016-2017, Indian banks gave out total non-food credit worth Rs 3,65,500 crore. Banks give working-capital loans to the Food Corporation of India(FCI) to carry out its procurement actions. FCI primarily buys rice and wheat directly from Indian farmers using the loans it takes from banks. When these loans are subtracted from overall loans given out by banks, we arrive at non-food credit.

In 2015-2016, the total non-food credit of banks had amounted to Rs 7,02,400 crore. What this means that non-food credit came crashing down by close to 48 per cent during the course of 2016-2017, the last financial year. To put it simply, this basically means that in 2016-2017, banks lent around half of what they had lent out in 2015-2016.

The important question is why has this happened? A major reason for this is that the total outstanding loans to industry has actually shrunk in 2016-2017(between April 2016 and February 2017, which is the latest data available) by Rs 60,064 crore. This basically means that Indian banks on the whole, did not give a single new rupee to industry as a loan during the course of 2016-2017.

And the reason for that is very straightforward. Over the years many corporates have defaulted on the loans they had taken on from banks, in particular public sector banks. And this explains why banks are not in the mood to lend to corporates anymore. As they say, one bitten twice shy.

In fact, as on December 31, 2016, the gross non-performing assets or bad loans of public sector banks had stood at Rs 6,46,199 crore, having jumped by 137 per cent over a period of two years. Bad loans are essentially loans in which the repayment from a borrower has been due for 90 days or more. The bad loans of private banks as on December 31, 2016, stood at Rs 86,124 crore.

A major chunk of these defaults has come from corporates. As of March 31, 2016, the total corporate bad loans of public sector banks had stood at Rs 3,36,124 crore or 11.95 per cent of the total loans given out to corporates. It formed a little more than 62 per cent of the total bad loans. This is the latest number I could find in this context. There is enough anecdotal evidence to suggest that the situation has worsened since then.

Given this, as I said earlier, banks are not in the mood to lend to corporates. Hence, their overall lending for 2016-2017 has shrunk by half in comparison to 2015-2016.

The interesting thing is that while Indian banks may not be lending as much, the other sources of funding haven’t really dried up. Private placements of debt jumped up majorly in 2016-2017 in comparison to 2015-2016 and so did issuance of commercial paper by non-financial entities. Over and above this, the foreign direct investment into the country continued to remain strong. During 2016-2017, FDI worth Rs 2,53,500 crore came into the country. This was more or less similar to the amount that came in 2015-2016.

In total, the flow of financial resources to the commercial sector stood at Rs 1,262,000 crore, the RBI estimate suggests. This is around 12.1 per cent lower than the last year. Hence, the overall availability of money has shrunk but the situation is not as bad as bank lending data makes it out to be.

Basically, while banks may not want to lend to corporates, there are other sources of funding that do remain strong. Having said that, a fall of more than 12 per cent in total flow of financial resources to the commercial sector, is not a good sign on the economic front. This can only be corrected only after banks come back into the mood to lend to corporates. And that will only happen when banks get into a position where they are able to recover back from corporates a significant chunk of their bad loans. As of now no such signs are visible.

 

The column originally appeared in the Daily News and Analysis on April 25, 2017

Will RBI’s Latest Rescue Act Clean the Mess in Public Sector Banks?

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Late last week, the Reserve Bank of India(RBI) unleashed yet another weapon to clean up the mess that India’s public sector banks are in. The RBI reviewed and revised the preventive corrective action (PCA) framework for banks.

At a very simplistic level, the PCA framework essentially will restrict the ability of any bank to go about their normal business, in case they don’t meet certain performance parameters. The idea is to ensure that banks do not get into a further mess.

The RBI has basically set three risk levels for the PCA framework to kick-in. Take the case of bad loans or net non-performing assets(NPAs) of banks. (NPAs are essentially loans which borrowers have defaulted on and are no longer repaying. These NPAs are referred to as gross NPAs. Against, the gross NPAs, the banks set aside a sum of money referred to as provisions. Once these provisions are subtracted from gross NPAs what remains are net NPAs).

Let’s say the net NPA of a bank is greater than or equal to 6 per cent but less than 9 per cent. In this case, the bank will face a restriction on dividend distribution. This is the first risk level of the PCA framework. In case, the net NPA is greater than or equal to 9 per cent and less than 12 per cent, along with dividend restrictions the bank will also face a restriction on branch expansion and at the same time will have to increase its provisions or the money it sets asides against gross NPAs. This is the second risk level of the PCA framework.

If the net NPA is greater than or equal to 12 per cent, then along with the dividend restrictions, restrictions on bank expansion, greater provisioning, the banks will have to limit the management compensation and directors’ fees. This is the third risk level of the PCA framework.

Along with net NPAs, the other performance parameters that the RBI plans to take a look at as a part of the PCA framework are the capital adequacy ratio, return on assets and the leverage of the bank. If the bank does not meet the RBI set levels of these parameters, the actions highlighted above will kick-in.

Over and above this, there are other actions that can kick-in. These include:

  1. Special audit of the bank
  2. A detailed review of business model in terms of sustainability of the business model of the bank.
  3. RBI to actively engage with the bank’s Board on various aspects as considered appropriate.
  4. RBI to recommend to owners (Government/ promoters/ parent of foreign bank branch) to bring in new management/ Board.
  5. RBI to supersede the Board.
  6. Reduction in exposure to high risk sectors to conserve capital.
  7. Preparation of time bound plan and commitment for reduction of stock of NPAs.
  8. Preparation of and commitment to plan for containing generation of fresh NPAs.
  9. Strengthening of loan review mechanism.
  10. Restriction of staff expansion.
  11. Restrictions on entering into new lines of business.
  12. Restrictions on accessing/ renewing wholesale deposits/ costly deposits/ certificates of deposits.
  13. Reduction in loan concentrations; in identified sectors, industries or borrowers.

If you look at the above actions, other than the RBI superseding the board of the bank, the other steps are more or less what any bank which is in trouble would undertake. The question is will the PCA unravel the mess that the Indian banks, in particular the government owned public sector banks, are currently in.

The biggest problem for the public sector banks has been the fact that their gross NPAs have been increasing at a very rapid rate. Between December 2014 and December 2016, the gross NPAs of public sector banks increased by 137 per cent to Rs 6.46 lakh crore.

What is the reason for this huge and sudden increase in gross NPAs? A major reason lies in the fact that banks have been recognising their bad loans as bad loans at a very slow speed. The question is the recognition of bad loans as bad loans over? Have all bad loans been recognised as bad loans? Or are banks still resorting to accounting gimmicks and postponing the recognition of bad loans? This is a question which only the banks or the RBI can answer.

The most important step in cleaning up the balance sheets of Indian banks is ensuring that all the bad loans have been recognised as bad loans. A problem can be solved only after it’s properly identified. The tendency not recognise bad loans as bad loans and project a financial picture which is incorrect needs to end.

The second biggest problem for Indian banks has been the poor recovery rate of bad loans (i.e. net NPAs in this case). Data from RBI shows that in 2015-2016, the recovery rate fell to 10.3 per cent of the net NPAs. In 2014-2015, it was at 12.4 per cent. In 2013-2014 and 2012-2013, the recovery rates were even better at 18.4 per cent and 22 per cent, respectively.

This basically means that the ability of banks to recover bad loans has gone down over the years. Will the PCA framework be able to help on this count? It doesn’t seem so. A greater portion of the bad loans need to be recovered from corporate India. As the Economic Survey points out: “The stressed debt is heavily concentrated in large companies.” Hence, any major recovery from large companies will need a lot of political will something, which is something the RBI cannot do anything about.

The PCA framework will kick-in depending on the performance of banks as on March 31, 2017. But taking the net NPA numbers as on December 31, 2016, how does the scene look like for public sector banks? There are 21 public sector banks which currently have a net NPA ratio of greater than 6 per cent. Hence, the PCA framework will apply to all of these banks. The first risk level of the PCA framework will apply to all these banks.

Of these ten banks have an NPA of greater than 9 per cent. The second risk level of the PCA framework will apply to these banks. Two banks have an NPA of greater than 12 per cent. The Indian Overseas Bank is the worst of the lot at 14.3 per cent. The State Bank of Patiala came in next as of December 2016. This bank has since been merged with the State Bank of India.

The PCA framework will essentially limit the ability of these banks to carry out business and hence, limit further damage to the bank and the financial system.

Nevertheless, there is no way the framework will clear up the mess that these banks are in. For that what is needed is a lot of political will to go after corporates and recover the bad loans that are outstanding. The question is do we have that kind of political will?

The column originally appeared on Firstpost on April 19, 2017 

Decoding Cash Withdrawal Fee: Do Private Banks Want Only Millennials as Customers?

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If you are the kind who likes to visit his or her bank branch regularly to withdraw or deposit cash, the message from the big three new generation private sector banks (ICICI Bank, HDFC Bank and Axis Bank) is very clear. They do not want you to come visiting their branches. Or at least not very regularly.

Starting March 1, 2017, HDFC Bank, will charge you a minimum of Rs 150 in case you carry out more than four cash transactions (withdrawals as well as deposits) a month in your home branch. In case of Axis Bank and ICICI Bank, the charge has been in effect from early January 2017, when it was re-introduced. While ICICI Bank allows the first four transactions to be free, in case of Axis Bank the limit is set at five transactions.

The move is likely to impact senior citizens and others who are still not used to the idea of withdrawing money from an ATM or carrying out digital transactions using their debit cards, the most.

Also, the banks will charge Rs 5 per Rs 1,000 as a fee in order to allow you to withdraw or deposit cash, once the number of free transactions has been exhausted. This essentially means a charge of 0.5 per cent. This is subject to a minimum charge of Rs 150 for every transaction. Hence, the 0.5 per cent charge actually comes into effect only if you withdraw or deposit more than Rs 30,000 (Rs 150 divided by 0.5 per cent) at one go.

Now what is the logic of having a minimum charge of Rs 150, which is not low by any stretch of imagination? The idea is basically to tell the bank customers to come to the branch only if a substantial amount of cash needs to be withdrawn or deposited, even after the free transactions have been exhausted.

Let’s say you want to withdraw Rs 5,000 from the bank. This would mean paying the bank a charge of Rs 150 or 3 per cent of the withdrawn amount. Hence, it would just make sense to go to the ATM and withdraw the money, free of cost, and not drop-in at the branch.

From the point of view of the bank, this move makes immense sense, given that the cost of servicing a customer at the branch is the highest. A  November 2015 report in The Hindu points out: “On an average, a branch banking transaction costs a bank about Rs 40-50 per customer, while an internet or mobile transaction brings down the costs to Rs 15-30 per customer.”

Also, the move suggests that the new generation private sector banks are only looking for a certain kind of customer, the one who does not want to come to the branch.

As R Gandhi, one of the deputy governors of the Reserve Bank of India had said in an August 2016 speech: “There is a new generation of young people (known as millennials). They have different expectations and their ways of interacting with banks are also different. They prefer not to come to banks for banking services. Rather they would prefer to avail the services through online and social media based platforms.” This is the kind of customer that the new generation private sector banks want.

If you are the kind who likes to visit his bank branch regularly, then you are clearly not welcome at new generation private sector banks. Public sector banks are the place for you.

Post script: Kotak Mahindra Bank, the fourth largest new generation private sector banks, will do the same as the Big three when it comes to cash transactions, from April 1, 2017, onwards. The details can be checked out here.

The column was originally published on Business Standard online on March 3, 2017