Pile Of Rs 6 Lakh Crore In Stressed Loans Still Not Provided For: McKinsey
Reported bad loans of Indian banks, as measured by gross non-performing assets (NPAs), crossed Rs 7 lakh crore at the end of the December quarter. Add loans that have been restructured and may have a high probability of turning bad, and you get an even higher amount of stressed assets -- closer to Rs 9 lakh crore.
Only Rs 3 lakh crore of these stressed loans have been provided for, leaving a pool of Rs 6 lakh crore in stressed assets that remain uncovered. That’s the way Renny Thomas, senior partner and head of the financial services practice at McKinsey & Co., sums up the problem. The number per se is not the problem. The fact that resolution of these stressed loans is nowhere in sight is, Thomas said in a conversation with BloombergQuint on Tuesday.
The Reserve Bank of India understands this. “We can choose status quo, but this would be insanity...” said Viral Acharya, deputy governor at the RBI, in a speech on Tuesday evening. He warned of a Japanese or Italian-style outcome if the problem was allowed to fester much longer. Both economies went through a protracted slowdown.
According to Thomas, all you have to do is compare the stressed loans that haven’t yet been provided for with the net worth of the banking sector. That tells you how uncomfortable the situation is.
I think if you look at the recognized numbers, we have Rs 9 trillion in stressed loans in the system, of which about Rs 3 trillion have been provided for. So we have a situation where you have about Rs 6 trillion which is actually not provided for in the banking system. If you compare that to the total net worth of the banking system, which is about Rs 8 trillion, its a very uncomfortable situation to be in. Then you have the likelyhood of more slippages. So its not like you have seen the end of the cycle of slippages. Given that, the numbers remain worrying.Renny Thomas, Senior Partner & Head-Financial Services India, McKinsey & Co.
While bankers say that the industry may have hit the peak of the bad loan crisis, Thomas is not so sure. He points to the vicious cycle sparked off by the surge in NPAs, which has led to stagnation in the industrial economy. This, in turn, could lead to more assets turning bad.
That the industrial economy is stagnating is clear from economic data. Growth in industrial output for the April-December period was at a meagre 0.3 percent. Advance GDP estimates point to a contraction in gross fixed capital formation, an indicator of private investment, in the current fiscal.
All of this could mean that bad loans may not have peaked even though the official phase of recognition under the RBI’s asset quality review conducted in 2015 is over.
“This is a fairly dynamic situation. When you are in a vicious cycle and the industrial part of the economy is slowing, what you might see is that a company with an interest coverage ratio which was acceptable, as the economy slows further, you find that they are not able to service their loans as well,” explained Thomas.
Ideas Ideas Everywhere, No Resolution In Sight
There has been no shortage of ideas on how to resolve the bad loan mess. The RBI has introduced schemes ranging from Strategic Debt Restructuring (SDR) to S4A. The former gives banks the power to overthrow a management while the latter allows a conversion of part of the debt to equity. Private asset reconstruction companies (ARCs) have been encouraged. About six are operational; another six are in the works. Capital restrictions for ARCs have been lifted. An insolvency code has been put in place.
Nothing has worked. At least not at the pace it needs to.
In a scenario where we are not having resolution, the possibility of having a large-scale liquidation starts increasing. And there everyone loses value. The banks lose value, the shareholders lose value and the economy suffers because there is a loss of jobs. Further, there is a downstream effect on the SMEs and that worsens the system.Renny Thomas, Senior Partner & Head-Financial Services India, McKinsey & Co.
In his speech on Tuesday, Acharya, the RBI deputy governor, suggested another two options. The first is the creation of a Private Asset Management Company (PAMC) (or more than one) which would tackle assets which have near-term economic viability. These assets would be restructured in a way that debt is written down, promoter equity is diluted and their credit rating is improved. The PAMC, which would have no government involvement, would hold these assets till the assets are rehabilitated and, perhaps, eventually sold.
The second suggestion (which would likely work together with the first) is the creation of a National Asset Management Company (NAMC). This agency would be used to deal with tougher-to-resolve stressed assets in sectors like power where government intervention may be needed.
In making any of these solutions work, bankers and policymakers will have to overcome one fundamental issue -- the disaggregated nature of loans in the Indian banking sector.
If you look at what is coming in the way, one is the fundamentally disaggregated nature of these loans. There are up to a dozen lenders, and in some cases up to 30 lenders. In some instances, some of these loans have been sold to ARCs. Each one of them has different timelines and it is very difficult to converge them on a single path. So that is one major factor. The second major factor is that there is very little sectoral coordination. In some cases, a sectoral solution is required. Particularly in categories like infrastructure, including power, the time horizon of resolution may be much longer, which means it is very difficult to get private investors in. And finally, in some of these instances, small tweaks may be needed in the resolution framework.Renny Thomas, Senior Partner & Head-Financial Services India, McKinsey & Co.
Like Acharya, Thomas suggests that India draw on the global experience. He points to models used in Indonesia and Spain as possible structures that could be adopted. The US model of a Troubled Asset Relief Program (TARP) is also worth studying, although India may not be in a position to commit the kind of capital that governments in some of these countries have had to do.
A third, less capital-intensive, solution used in some countries includes the setting up of an Asset Management Agency.
In these instances, the banks got together, broke up the loans into a sustainable and unsustainable part. The sustainable part was made into a performing loan and the unsustainable part was converted into equity. And the equity rights were aggregated across banks and transferred to a management company. This management company then took control of the assets and ran the assets on behalf of the banks till they could drive an operational turnaround. You can then sell the asset over the right period of time to recover value for the banks.Renny Thomas, Senior Partner & Head-Financial Services India, McKinsey & Co.
Consolidation: Now Or Later?
Never waste a good crisis, they say. The question then is whether this bad loan crisis should be used to consolidate the banking sector. Acharya, in his Tuesday speech, suggested the time to consolidate is now.
Thomas shares a similar view. He points to the fact that smaller public sector banks are losing market share since they don’t have the capital to grow their books. The structure of the industry, driven by market forces, is already changing. He adds that the global experience suggests that consolidation tends to be linked to periods of stress in the banking sector.
Empirically, if you look at the banking sector, almost every time the banking sector has gone through a crisis, it has happened in tandem with banking sector consolidation. Whether you look at Indonesia or Spain, fundamentally the industry goes through consolidation. That is how it has empirically played out. We’ll have to see how it plays out in India.Renny Thomas, Senior Partner & Head - Financial Services India, McKinsey & Co.
Listen to the conversation here: