Good news amid Brexit gloom: The toxic loan problem in Indian banks may have peaked

Bad loans that way.
Bad loans that way.
Image: Reuters/Brendan McDermid
We may earn a commission from links on this page.

The bad loan mess at Indian banks may be easing.

Some six months after Reserve Bank of India (RBI) governor Raghuram Rajan began a massive clean-up, a review by Nomura shows that Indian banks have already recognised most of their stressed loans as non-performing assets (NPAs) or have put them on a watch-list. An NPA is a loan on which interest or principal hasn’t been paid for more than 90 days.

“Our detailed analysis of a breakdown of the stressed assets of banks gives us a conviction that we are nearing the peak in NPAs, especially for public sector units, as (nearly) 30-50% of their exposure in stressed sectors have been either marked as NPAs or restructured,” the Nomura report on June 23, authored by analysts Adarsh Parasrampuria and Amit Nanavati, said.

Banks in Asia’s third-largest economy have been given a March 2017 deadline to make provisions to cover stressed assets on balance sheets. RBI issued this directive after an intensive asset quality review (AQR). Most of these bad loans, estimated at some Rs13 lakh crore ($192 billion), were accumulated during the global economic slowdown. Lacklustre demand in the economy and slow project execution—mainly in the infrastructure, power, and metals sectors—made it difficult for borrowers to repay.

Deep surgery

The action on bad loans is one of the highlights of Rajan’s tenure at the RBI. On his way out after serving three years, the central bank chief has been rather vocal about the dangers of mounting toxic loans.

“The cleaning up of bank balance sheets and the restoration of credit growth are vital and related elements in the growth agenda. The government and the RBI are helping our public sector banks in this difficult but critical task,” Rajan said in a June 22 speech.

“The good news is that banks are getting into the spirit of cleanup and are pursuing reluctant promoters to take the necessary steps to rehabilitate projects… I know the process is working, so public sector banks will soon be set to finance the enormous needs of this economy once again,” he added.

The Nomura study said that, after the AQR, many banks “have gone beyond the regulator’s directive of recognising just near-term stress and, hence, the declaration of recognition of stress is nearing the end.” For instance, total NPAs and restructured assets among public sector banks increased between 10% and 17% of loans. Moreover, between 2% and 3% of loans were put on watch-list for stress.

This hasn’t been easy, though. Lenders have taken huge hits. For the three months ended March 31, 2016, cumulative losses at 20 Indian state-owned banks stood at nearly $2 billion. But such one-time bleeding was necessary to prevent a future bloodbath, as Rajan acknowledged earlier this year:

If the bank wants to pretend that everything is alright with the loan, it can only apply band-aids. For any more, drastic action would require NPA classification… But to do deep surgery such as restructuring or writing down loans, the bank has to recognise it has a problem, classify the asset as a non-performing asset.