As bad loans balloon to unprecedented levels, we take a look at why this has happened

Kotak Institutional Equities (Kotak), in its recent report, has voiced its concern over the decline in asset quality in the banking sector, including private banks. Kotak stated, “2QFY13 results of PSU banks showed further increase in their non-performing loans (NPLs) and restructured loans from their already high levels while private banks had a relatively benign quarter with a modest decline in asset quality” Moneylife had already written an extensive cover story on public sector banks’ woes and their structural problems. The cover story can be accessed here. The story revealed that bad loans of public sector banks grew by a whopping 56% during the 2011-12 fiscal and the reason had nothing to do with the economy but the way the banks were managed.
 

While there isn’t much of a difference in the loan composition between private and public sector banks (PSBs), the former tend to have a much more prudent credit policy to make sure that debtors are solvent and have the capacity to repay the principal. Kotak mentions that there was a steep rise in restructured loans, especially amongst PSBs. The table below illustrates this:

As you can see, restructured loans are fairly stable in private banks, even though numbers have gone up in some private banks. But, by and large, private banks have vastly outperformed PSBs. In fact, the Reserve Bank of India (RBI) had admitted that 15% of PSB restructured assets had become bad debts. The main differences between private and PSBs is the way both are run. PSBs do not have a shareholding mindset to make profits and are often under the watchful eyes of the government. Sometimes, things can get political, even though on paper, a loan can turn bad. A case in point is how inept PSBs had been in bailing out companies like Air India and more pertinently, a private carrier that is Kingfisher, which has begged PSBs to use tax payers’ money for a bailout. The government has simply forced PSBs to throw good money (i.e. tax payers’ money) over bad loans.
 

Several other reasons explain poor performance of PBSs. They are:

1. Inadequate and poor credit assessment. Even big companies like Paramount Airways has come under the CBI scanner for causing losses to PSBs. What makes PSBs choose such companies? And, of course, there’s Kingfisher and Air India.
2. Large pending cases with the debt recovery tribunal with scant resources in courts. This delays recovery of loans, which continue to be in PSBs’ books.
3. Borrowers can obtain stay orders from higher courts and prevent banks from enforcing the securities, despite SAFAESI Act.
4. The appointment of chief executive officers (CEOs) of PSBs is a game of musical chairs and inherently political rather than based on merits.
5. Vertical organisational structure prevents PSBs from keeping a close watch on funds.

A more detailed analysis of the above can be found in our cover story here.
 

A Moneylife index comparing returns of public sector banks (PSBs) and private banks threw up some very interesting findings, where investing in private banks would have increased boosted your returns by 50%, over three years—an enormous difference.
 

Kotak mentions, “The government and regulator may want to ensure better lending practices at PSU banks or enforce better practices (lending and otherwise) of private-sector companies on PSBs.” However, we feel this is just wishful thinking. It will take years for cultural changes to impact PSBs, in a good way. Policy makers and regulators would need to get their act together, now. Our columnist, MG Warrier, had written about banking reforms in detail over here.