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.

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 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.

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.

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.

Listen to the conversation here: