How best to nurse the weak banks back to health

Should we continue to nurse them back to health while teaching them not to make the same mistakes?
Even, explore the option of euthanasia for a few incorrigible ones?
Or, relax the PCA norms, push them to lending and spend more tax payers’ money till they are buried under a fresh pile of NPAs?
The choice clearly is between prompt corrective action and slow but sure destruction, says Tamal Bandyopadhyay.

Illustration: Uttam Ghosh/Rediff.com

The Reserve Bank of India’s (RBI) last board meeting in Mumbai continued for hours, the longest in its recent history.

Much time was spent discussing the so-called prompt corrective action (PCA) being imposed on 11 public sector banks (PSBs) and the liquidity crunch for non-banking finance companies.

This is not the first time that PCA is in the limelight.

An August report of the parliamentary standing committee on finance had pointed out that the PCA framework may end up bringing more PSBs under its ambit “which may aggravate matters and culminate in a vicious cycle in the banking sector and the economy at large”. So, the norms should be relaxed.

It’s a far-fetched analogy but I am tempted to narrate a story I had heard many times from my father.

One of his colleagues had the twin problems of high sugar and high blood pressure, accompanied by high cholesterol.

Often, he would be hospitalised but once out he would gorge on spicy mutton curry and dozens of rasgulla.

Being in a denial mode didn’t help him. By the time the inevitable happened, his family turned a pauper as the cost of treatment was too high.\

The banks have come under PCA - which restrains their activities - because they are not healthy.

Piling of bad loans, eroding capital and mismanagement have led to this.

Yet, the government wants the RBI to relax the PCA norms and allow them to lend because if they lend to consumers that will fuel growth.

Isn’t the loan growth in Indian banking industry quite healthy now?

Till mid-October, bank credit has grown 14.4 per cent, double of last year and more than nominal GDP growth (loosely, GDP at constant prices plus inflation).

The trend is expected to get further momentum.

Indeed, between 2006 and 2008, when India’s economy grew at 9 per cent and more, the bank credit growth was three times the GDP growth but that led to overheating and sowed the seeds of inflation and toxic assets.

Incidentally, in December 2017 when Bank of India (BoI) came under PCA, both the RBI and the finance ministry had to step in to quell widespread rumours of some PSBs being closed.

"No question of closing down any bank. The government is strengthening PSBs by a Rs 2.11 trillion recapitalisation plan… Recap, reforms roadmap for PSBs firmly on track,” financial services secretary Rajiv Kumar had tweeted then and the RBI issued a release, clarifying “the PCA framework is not intended to constrain normal operations of the banks for the general public”.

Introduced in December 2002, and recast in April 2017, the framework will be reviewed again in 2020.

It tracks three key areas of bank operations - capital, asset quality and profitability - through the ratio of capital to risk-weighted assets (CRAR), net non-performing assets (NPAs) as a percentage of loans and return on assets (RoA).

It also monitors the leverage of a bank - the amount of debt used for financing assets.

There are three risk thresholds.

Once a bank breaches the “risk threshold 3”, it becomes a candidate for merger, reconstruction, or even winding up.

Breaching of the first two thresholds makes a bank subject to restrictions on dividend distribution and remittance of profits (in case of foreign banks), branch expansion and compensation of senior management, among others.

For the RBI, PCA is a supervisory tool which monitors certain performance indicators as an early warning exercise and facilitates the banks to take corrective measures within a timeframe to restore their financial health.

So far, 11 PSBs and one private bank have been placed under PCA.

They are United Bank of India (UBI), Indian Overseas Bank (IOB), IDBI Bank, Uco Bank, Dena Bank, Central Bank of India, Bank of Maharashtra (BoM), Oriental Bank of Commerce (OBC), Corporation Bank, BoI and Allahabad Bank (chronologically, in this order).

The lone private lender is Dhanalakshmi Bank. Collectively, the 11 PSBs have around one-fifth market share both in advances and deposits of Indian banking system.

Even though they have been placed under PCR at different points between February 2014 and January 2018, let’s see how they have performed since December 2015 when RBI forced all banks to clean up their balance sheets.

During this period, IDBI Bank has made Rs200 billion loss, followed by BoI (Rs 15,000 crore), IOB (Rs 12,990 crore), Central Bank of India (Rs 10,800 crore), Uco Bank (Rs 10,100 crore), Allahabad Bank (Rs 8,350 crore), OBC (Rs 8,000 crore), Corporation Bank (Rs 5,000 crore), Dena Bank (Rs 4,500 crore), BoM (Rs 3,750 crore) and UBI (Rs 2,250 crore).

IDBI Bank’s gross NPAs as a percentage of total assets rose from 8.94 per cent in December 2015 to 30.78 per cent in June 2018.

The story is no different for others: Uco Bank’s gross NPA has grown from 10.98 per cent to 25.71 per cent; IOB, from 12.64 per cent to 25.64 per cent; UBI, from 9.57 per cent to 22.73 per cent; Dena Bank, from 9.85 per cent to 22.69 per cent, Central Bank, from 8.95 per cent to 22.69 per cent; and BoM, from 7.97 per cent to 21.18 per cent.

Similarly, nine of the 11 banks had at least 10.6 per cent and up to 18.76 per cent net NPAs in June 2018.

On the positive side, the erosion in capital has been arrested and CRAR has been maintained at the internally accepted levels.

This has been possible because of infusion of capital and contraction in their advances.

The government has infused at least Rs 230,000 crore in PSBs since 2015 and more than half of this has gone to these 11 banks which have received Rs 63,500 crore since 2018.

Maintaining capital apart, the fund infusion has helped these banks provide more for bad assets.

Their provision coverage ratio is now around  50 per cent.

Should we continue to nurse them back to health while teaching them not to make the same mistakes?

Even, explore the option of euthanasia for a few incorrigible ones?

Or, relax the PCA norms, push them to lending and spend more tax payers’ money till they are buried under a fresh pile of NPAs?

The choice clearly is between prompt corrective action and slow but sure destruction.

Had the family of my father’s friend restrained him from gorging on mutton curry and rasgulla, they would not have needed to spend so much to keep him alive and even die.

Tamal Bandyopadhyay, a consulting editor of Business Standard, is an author.