India's banking crisis in the making?

Thu, 15 Oct Pre-Open

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The gross bad loans of the Indian banks as of March 2015 rose to Rs 3.1 trillion or 4.6% of total loans, as per data published by the central bank. According to RBI's annual report released in June 2015, six sectors account for the majority of bad debt in Indian banks: infrastructure, metals, textiles, chemicals, engineering and mining. The six account for only 30% of the total credit, but 36% of the total bad debts in bank books.

The banks are opting to refinance the stressed assets under the 5/25 scheme. Under the 5/25 scheme, loans can be repaid over a maximum period of 25 years and the banks will refinance the loans every five years. The major positive is that loans are not considered as 'restructured loans'. Therefore, no provisioning is required to be made on the same, that is, they are not recognized as Non-Performing Assets (NPA). As per an article in Outlook Business over Rs 1 trillion of loans have been refinanced under this scheme. In some Public Sector banks (PSU) there is a tendency to not recognize NPAs. The management of the PSU banks goes through vigilance mechanism and is afraid that any large NPAs will be considered bad from their career perspective. Therefore, currently more and more loans are being refinanced under the 5/25 scheme.

The main risk attached to the scheme is that the bank has to refinance the loan every five years. This leads to outflow of additional capital. In case of a situation where the stranded projects do not revive in the future, additional capital will also be in jeopardy.

Further, some are also of the view that the 5/25 scheme is better than corporate debt restructuring (CDR). 5/25 scheme allows the corporates to increase the tenure of the loans so that they can match each projects inflow and outflow. Whereas, CDR provides a temporary relief and the financials of the company won't change.

The banks and RBI are together taking precautionary measures to stop the piling up of bad loans. The Reserve Bank of India (RBI) allowed banks to seize control of a company if a debt recast fails, replace the management, and sell their stake in the defaulting company as soon as possible to recover dues. This is one of the central bank's most aggressive steps to rein in willful defaulters and curb rising bad loans. In a recent article in The 5 Minute Wrapup, Radhika Pandit, Managing Editor of ValuePro, discussed the consequences of the 5/25 scheme on the banking sector.

However, with sectors like telecom, infrastructure and power far from recovery, banks will continue to feel the stress on asset quality. NPAs have so far not been a systemic risk for India's banking sector. Investors need to be very cautious about selecting entities with a track record of good credit history.