IT'S ONE OF THE most important achievements of the banking industry over last few years — sorting the bad loan mess that once threatened to take the entire sector down with it. Regulator Reserve Bank of India (RBI) and Centre laid the groundwork to resolve non-performing assets (NPAs). While RBI ordered steps such as asset quality review to recognise the extent of the bad loan problem, the government came out with the Insolvency And Bankruptcy Code (IBC) framework under which banks can recover loans to companies in an orderly and time-bound manner. After all, corporate loans are the biggest chunk on bank books. "Gross NPAs in corporate loans peaked at roughly 16% in March 2018. We expect them to touch 2% by March 2024," says Krishnan Sitaraman, senior director and chief ratings officer at Crisil Ratings. As NPAs in corporate loans fell, overall gross NPAs halved in just three years from 8.2% of outstanding loans in FY20 to 4.2% in FY23. Gross NPAs are loans a bank fails to collect while net NPA is the number after deducting provisioning for doubtful debt. Banking sector's gross NPAs had peaked at 11.2% in March 2018. Rating agencies Crisil and India Ratings expect them to touch a decade low of 3.3-3.8% by FY24-end. A loan is classified as an NPA if the borrower does not make interest or principal repayments for 90 days.
While IBC helped banks in loan recovery, one of its unintended impacts was imposing discipline on companies which, fearing bankruptcy proceedings, started focusing more on free cash flows and meeting debt obligations. RBI and government also encouraged banks to bite the bullet on recovering their money or writing off loans where chances of getting back money were slim. Hence, fresh slippages have been negligible over past few years. In last quarter (Q4 FY23), banks made two major recoveries in Sintex Industries and Jaypee Infratech. Reliance Industries, the winner of the Sintex bid, infused ₹1,500 crore in the company under the resolution plan. Jaypee Infratech, part of the first 12 accounts referred for bankruptcy in June 2017, received National Company Law Tribunal (NCLT) approval for its acquisition by Suraksha Reality and Lakshdeep Investments and Finance. These two cases made way for recovery of dues worth ₹23,000 crore. Videocon Industries, Future Retail, Reliance Capital, SREI Infrastructure and Lanco Amarkantak are among the big names still pending for resolution.
"Fresh NPA generation has been lower over last few years because the number of wilful defaulters has come down. They are apprehensive that IBC has given banks power to take over a company in case of a default. Promoters don’t want to lose control of their companies," says Sitaraman of Crisil.
Corporate delinquencies over last one decade also taught banks many lessons in risk management. They have started increasing share of secured portfolio and shifting focus from corporate to retail loans where chances of defaults are lower as risk is distributed over larger number of loans. "Banks have improved their risk management and credit appraisal processes," says Sitaraman of Crisil.
The Winners
Among top 10 banks by assets, HDFC Bank, Axis Bank, ICICI Bank and SBI had lowest gross NPA ratios, in the range of 1.12-2.78%, in FY23. Punjab National Bank, Union Bank Of India and Canara Bank had highest gross NPAs at 8.74%, 7.53% and 5.35%, respectively. Net NPAs remained in the range of 0.27-2.72%.
YES Bank reported a substantial fall in gross NPAs from 13.9% in FY22 to 2.17% in FY23, thanks to transfer of bad loans to JC Flowers Asset Reconstruction Company in fourth quarter of FY23. Central Bank of India reported gross NPAs of 14.8% in FY22 and 8.44% in FY23. IDBI Bank recorded the worst gross NPA ratio of 19.1% in FY22. It fell to 6.38% in FY23.
"Most banks reported flat or lower slippages sequentially as incremental stress is low and majority of stressed restructured loans have already slipped. Select private banks such as Bandhan Bank saw a substantial decline in slippages after the jump in third quarter FY23. Slippages for frontline banks are near or even below pre-Covid levels,” says a report by Kotak Institutional Equities. The report also highlights that most recoveries have come from granular exposures in retail and MSME segments. “Most lumpy recoveries are already behind us. Many banks have been offering various settlement schemes to delinquent customers to resolve stress on balance sheets," says the report.
Asset quality, therefore, is less of a challenge for banks now. But going forward, one needs to watch out for migration to the ECL (expected credit loss) regime for provisioning. In January, RBI had released a discussion paper on ECL-based provisioning under which banks will have to classify financial assets like loans, loan sanctions, guarantees and investments in Stage 1, Stage 2 and Stage 3 categories depending upon assessed credit losses. This will contrast with the existing approach under which step-up provisioning is made based on the period the account has been in the NPA category.
There are concerns that provisioning levels will rise after the ECL regime kicks in. ICRA believes banks with higher share of restructured loans, 60-plus 'days past due' loans and off-balance sheet exposures will face a higher impact. Banks with lower capital cushions will have to raise funds to manage the transition, it says. The industry is awaiting more clarity on final methodology for ECL calculation to analyse its impact on profitability and capital ratios.
"Change in accounting treatment will not fundamentally alter the performance of the banking system but only result in upfronting of provisioning costs. We believe we are in a period where slippages and credit costs will get closer to all-time lows. Nevertheless, we continue to be watchful about how the situation evolves," says the Kotak report.
One expected risk is monsoon, which will decide the performance of the retail portfolio. "There are chances of NPAs rising, particularly in retail, due to rise in interest rates since May 2022," says Jyoti Prakash Gadia, managing director, Resurgent India, a Gurugram-based corporate financial advisory firm.
MSME loans are also an area that needs to be watched thanks to global slowdown hurting export-led businesses. "MSMEs may face stress due to inadequate increase in demand so far and impending end of moratorium on restructured advances implemented during the pandemic," says Gadia.
NPAs move in cycles. It is inevitable that they will bottom out and rise again. "As private capex picks up pace, corporate borrowings will increase. If leverage goes beyond what can be sustained by cash flows, there could be defaults," says Sitaraman of Crisil.
However, structural improvements will ensure that banks don’t revisit their peak NPA levels. "NPAs peaked at 24% in mid-90s. In the recent cycle, they peaked at 11.2%. Structurally, NPA levels will improve even as the NPA cycle keeps rotating," says Sitaraman.