Hysteria over NPAs is not helpful

India's banking system, according to media reports, has stressed assets of about Rs 800,000 crore or about 11% of total assets. NPAs are a little over 4% and the rest are restructured assets. A quarter of restructured assets typically turn into NPAs. That means an NPA level of around 6%. That is way below the level of 15% in 1996-96. The NPA situation is challenging but not alarming, as the RBI governor himself has pointed out.

But that's not the impression you would get going by screaming newspaper headlines and raucous discussions on TV. You would also think that all of the NPAs reflect crony capitalism and are the work of crooked politicians and businessmen, aided and abetted by public sector banks (PSBs). Two solutions are being prescribed accordingly. Privatise PSBs- the government has ruled these out. Instead, the government would prefer consolidation of banks: as the FM puts it, we need strong banks, not many banks.

Let me deal with the diagnosis first. It's sheer nonsense to say that all or most of the NPAs are the result of poor judgement or mala fide decisions. Banking is a play on the economy. NPAs at PSBs reflect larger problems in the economy:

i. The global economic crisis is still unfolding and banks the world over are feeling the impact. European banks especially are in poor shape. A large number of banks are trading below their book value- as the papers mention, HDFC Bank is today worth more than global giant, Deutsche Bank.  The Indian economy, like other emerging markets, is facing the lagged impact of the global crisis. Banks are impacted as a result.

ii. More than half the stressed assets arising from five sectors- mining, iron steel, infrastructure, textiles and aviation. It was PSB finance that drove the infrastructure boom of 2004-08. So PSBs are more exposed to these sectors than private banks. They are more impacted as a result.

iii. Maybe PSBs should have been as clever as private banks and take a lower exposure to key sectors of the economy? Maybe they too should have focused on retail assets? Well, we don't have deep enough corporate bond markets. And we wound up development financial institutions years ago. So, if the PSBs don't fund key sectors, who's going to fund them?

iv. The infrastructure and related sectors have been impacted by several factors which could not have been anticipated: delays in land acquisition, problems with environmental clearance, adverse court judgements, a sudden slowdown in the Indian economy, etc. It's not that private banks judged these risks better because they too are exposed to the very groups and companies to which PSBs are exposed. It's just that they had lower exposures because their business focus is on other assets.

Let me now address the prescriptions.

•  Privatising PSBs is no insurance that the tax payer will not have to foot the bill arising from failed banks. Just look at the recurrent bouts of banking crises in over 100 economies worldwide. The media cost of recapitalising banks has been 6.8% of GDP. In India, the total recapitalisation cost over a two decade period of 0.5% of GDP. The cost of recapitalisation is not the real cost of banking failure. The real cost is lost economic growth. This cost can amount to 3% of GDP every year. India has not had a banking crisis. The cost of recapitalising PSBs is thus miniscule in relation to the larger cost arising from a banking crisis.
• Consolidation does not necessarily lead to a stronger bank. It's hard to make a success of mergers even in economies where the labour market has flexibility. Here, the HR issues would be very difficult to surmount. Since almost all PSBs are in a stressed state, it is not meaningful to add to the stress of an SBI or BoB by merging an even weaker bank with it. We must first rationalise and restructure all the weak banks. Then, we can take a view on which can continue on its own, which can be merged and which may be privatised.

 There is more to the banking sector than Kingfisher and Mr Mallya. The problems are fundamental and require addressing with a cool head. Hysteria will take us nowhere.

More in a couple of pieces I wrote recently:

http://thewire.in/2016/02/28/sense-and-nonsense-about-bank-losses-22972/

http://qz.com/626955/there-is-only-so-much-arun-jaitleys-budget-can-do-to-fix-the-rot-in-indias-banking-system/