#dnaEdit: Retrieving bad loans

Reports of loans extended by public sector banks turning sticky are appearing with increasing frequency these days. The Reserve Bank of India as well as the government have rightly expressed concern about the accumulated debts. But if this is cause for some real anxiety — it is particularly so for the common man. Because, it is the deposits of the common citizen in the banks which feed loans. And the possibility of loans turning bad tends to put these savings to risk. 

The figures of sticky loans for public sector banks are truly alarming. In 2001, bad loans were to a tune of 12% of the total advances. In 2011, these came down to 3.5% due to persistent focus of the issue. Since then, the proportion of bad loans — euphemistically called non-performing assets — has gone up, and currently stand at over 4.5%. In a recent review, some international agencies have brought attention to this weakness of Indian financial sector, particularly of public sector banks. 

Basically, there are two categories of bad loans: first, those of wilful defaulters; second, those which have turned bad because of external factors and reverse turn in the macro-economic situation. The wilful defaulters need harsh treatment; the second category needs nurturing. 

The RBI has taken the view that the economic slow down in the last two years has landed the industry segments in a spot. The borrowers are often not in a position to service the loan accounts. RBI hopes that once the economy turns around, many of these borrowers should come back to normalcy. 

Leaving these long term external factors aside, there are some inherent checks and balances which could prevent increasing stickiness in loan portfolios. First and foremost is the banks’ internal capability to evaluate the borrowers soundness and ability to repay. Banks should have the capacity to assess the viability of the loan-seeking projects. Currently, the banks do not possess the requisite expertise for this job. 

Second, the contracts giving loans should have inherent clauses for protecting the interests of banks — in case the loans are not serviced. It’s useful to recall in this context the earlier “conversion clause” under which any dues could be converted into share capital of the borrowing companies. This would then facilitate a quick management take over and replacement to secure interests of the banks. This clause was hotly contested and scrapped at the bidding of promoter shareholders. Given the rising incidence of bad loans and difficulty of recovering dues,  the convertibility clause may be revived again as a deterrent provision. 

Third, loans are now extended on the strength of recommendations of the credit rating agencies (CRAs). This has become an established global practice and even required under the Basel III agreement. Often, CRAs give  ‘triple A’ rating to companies or products which then quickly go under. However, even in such cases the CRAs go scot free, refusing to accept any responsibility. The Reserve Bank appears to be seized of this matter and is looking at options for putting some responsibilities on rating agencies. One of the ways should be to make their accreditation more stringent. 

At any rate, what is needed now is not to rue over the huge amounts of NPAs but to find ways of recovering the dues and prevent a repeat of the bad practice in future.