Fix asset quality of PSU banks, IMF tells India

A further weakening of bank and corporate balance sheets could pose risks to the nascent recovery of Indian economy, says the International Monetary Fund’s (IMF) staff report.

Over the past few years, there has been a sharp deterioration in the banks’ asset quality, especially of public sector banks (PSBs) that account for three quarters of the banking system assets.

Part of this decline in asset quality, as the report pointed out, is because of the high exposure of the banking system to infrastructure sector, projects in which continue to remain engulfed in regulatory and legal hurdles. 

The report estimated that non-performing assets (NPAs) for PSBs stood at 4.7% of total advances in 2013-14. This is higher than the NPAs for the entire banking system which rose to 4.1% in 2013-14. 

Further, restructured loans for PSBs are also estimated to be significantly higher at 7.2% as of March 2014, as opposed to 5.9% for the entire banking system. 

On the deterioration of corporate balance sheets, the report pointed out that corporate vulnerability indicators remain elevated, with the shares of loss-making companies and those with a leverage ratio of over two increased to 22.9 and 31.4 percent, respectively over the previous year.

As kick starting the investment cycle is conditional on improving bank asset quality and maintaining financial stability, the report recommended strengthening regulation for banks’ credit quality classification, increasing the provisioning particularly for all types of restructured assets and bolstering capital buffers in public sector banks which is critical to ensuring that banks are able to support the economic recovery. 

But herein lies the problem. Greater capital is required to meet the Basel III requirements and due to restructured loans being classified as NPAs. According to the Fund’s analysis, if the government were to provide the full amount of capital required by banks, it will cost between 1.2 to 1.7% of 2018-19 GDP. 

But given the government’s limited fiscal space it is unlikely to be able to provide the required capital. 

While many expected the Budget to provide clarity on this issue, it was silent on the issue of lowering its stake in PSBs and allowing them to raise capital directly from the markets. 

Other measures the report proposed involve improving debt recovery by banks by providing incentives to swiftly deal with delinquent borrowers and promoters, measures to enhance the corporate bond market in India and reworking the financial regulatory architecture based on the recommendations by the Financial Sector Legislative Reform Commission (FSLRC). On all these, the Budget has already announced certain measures in line with the recommendations. It has proposed a new bankruptcy law that is likely to help with debt recovery. It has also proposed setting up a public debt management agency that is likely to help create a more vibrant bond market and has indicated introducing the Indian Financial Code (IFC).