Hooray! India finally declares victory over bad loans

In all, the combined performance of public and private lenders fills our chests with pride.
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India has finally declared victory over bad loans, which literally left the banking industry on the breadline.

From record losses of Rs 85,390 crore in FY19, the 12 Public Sector Banks (PSBs) seem to have safely crossed over the path of hell to heaven, reporting a net profit of Rs 1.4 lakh crore in FY24, or a 34% increase over the pervious year. Likewise, the 26 private lenders, like disciplined soldiers, marched forward to net Rs 1.78 lakh crore in profits, or a 42% rise over FY23.

In all, the combined performance of public and private lenders fills our chests with pride, which is why, Prime Minister Narendra Modi flashed the sector's achievements like generals wear their medals with pride. The total net profit of listed PSBs as well as private sector banks in FY24 jumped 39% y-o-y to cross Rs 3 lakh crore for the first time, he declared last week.

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SBI, the model wingman

Among all, the country's largest lender SBI emerged as the model wingman, with its net profit jumping a jubilating 125% to Rs 20,968 crore during the March quarter -- the biggest quarterly profit by any Indian bank ever. For the full fiscal FY24 too, profit stood highest ever at Rs 61,077 crore, with private lender HDFC Bank coming a close second with a net profit of Rs 60,812 crore. Others like Bank of India, Bank of Maharashtra, and Indian Bank saw their FY24 net profits increase over 50% each.

What's working in the banks' favour is the rising credit growth, which boosted their interest income. Banks also kept bad loans in check, resulting in improved asset quality. PSBs saw credit growth of 11-16% in FY24, driven by retail loans, while corporate loans registered somewhat tepid growth. Sectorally, retail loans and loans to corporates had relatively lower bad loans as against loans to agriculture and MSMEs. Having scrapped the bottom of the barrel for toxic loans, banks now have Non-Performing Assets (NPAs) of less than 2%, which by any means is significant.

Looking back

Historically, development banks were the backbone of long-term infrastructure financing. But as they began folding in 1990s, PSBs entered the fray and as public-private partnerships thrived over the following decade, state-run lenders ramped up project financing to emerge as the dominant force for the infrastructure sector. It's this early aughts of the 2000s that birthed the troublesome twin-balance sheet problem.

Around that time, economic growth was booming, banks were encouraged to lend as corporates unleashed animal spirits. With corporate profitability at its highest, India Inc launched massive projects, mostly financed by banks. Perhaps little attention was paid to the financial viability of projects or the soundness of borrowing firms as the so-called 'phone-banking' became a norm. By 2007-08, the investment-to-GDP ratio reached 38%, while total non-food bank credit simply doubled between FY05 and FY09.

That's when the 2007-2009 global financial crisis struck, where advanced economies were squished like a bunch of grapes. Everywhere, growth and revenue projections fell and finance costs were up building stress on the books of both borrowers and lenders. Conventionally, Indian banks should have taken a deep breath to redirect their course, as sometimes both misfortune and good luck have the same face. But thanks to the government's 'stimulus festival', bank lending to infra projects continued unabated.

In all, during 2005-2013, the total bank lending expanded by over 15% annually in real terms, according to reports. This period also marked significant growth in total bank lending from both private and public banks, and by 2014, PSBs alone accounted for 70% of total bank credit, much of which was in large corporate loans.

Even as banks were on a lending spree, troubles began as early as 2010. The banking system faced challenges, as governance lapses in infra projects significantly increased the risk of stressed assets in PSBs. Instead of addressing the problem, the banking regulator compounded the problem further, as the credit restructuring schemes, otherwise known as evergreening, needlessly allowed lenders to push non-performing assets under the carpet.

As if this wasn't enough, under-capitalised banks rolled over loans to large, struggling borrowers just to avoid declaring them as bad loans. By FY17, these large borrowers constituted over half of all bank loan portfolios and almost 90% of NPAs in the banking system.

A deft stroke none expected

Finally, in February 2018, the central bank, under the inscrutable Governor Dr Urjit Patel did something none expected. With just one deft stroke, he tossed all existing stressed asset resolution tools into the bin. Until then, RBI was operating an alphabet soup of schemes, all of which were seen as untargeted "spray-and-pray" regulatory responses. So they were all mercilessly scrapped, with Patel replacing them with the over-arching Insolvency and Bankruptcy Code (IBC).

Though IBC was enacted in 2016, RBI's decisive action was a game-changer as far as corporate resolution process was concerned. Walking an extra mile, the RBI even identified 12 large borrowers, notoriously called the dirty dozen, assigning priority status for resolution. This was followed by another list of defaulting companies, but within a year, the central bank suffered a big blow.

In April 2019, the Supreme Court struck down RBI's February 12 circular or the Revised Framework for Resolution of Stressed Assets, 2018 that subsumed a jaw-dropping 28 debt restructuring schemes dating as far back as 2001.

But insolvency proceedings continued with set timelines, while banks faced penalties in case of failure to comply with guidelines for accounts involving restructuring or change in ownership. Importantly, RBI mandated that loans of over Rs 100 crore or more will need independent credit evaluation by authorised credit rating agencies.

Besides, the regulator strengthened supervision forcing banks to detect early warning signals for stressed accounts and promptly report defaults. As the stringent Asset Quality Review (AQR), a regulatory exercise identifying discrepancies in loan classification by banks began unearthing the toxic pile, there was a rise in banking frauds, including the colossal $2 billion fraud at the Punjab National Bank.

RBI forced lenders to make steep provisions towards all disbursals that had gone sour, which was a drag on banks' profitability. Yet, RBI persisted, perhaps convinced with the premise that sacrificing limbs for life was a better option.

As the bad loan resolution process was underway, the banking sector plunged into a game of whack-a-mole. The process not only revealed substantial underreporting of NPAs, leading to a collapse in public bank lending, but also saw a sudden decline in credit availability creating a vacuum. This spurred the growth of shadow banks or NBFCs. The financial system also faced additional challenges with the high-profile defaults of IL&FS and DHFL in 2018 and 2019. As if punching a bruise, the twin defaults set off a contagion effect, culminating in a liquidity crisis and loss of confidence in NBFCs.

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Then came the pandemic

The Indian banking and financial sector was barely coping, and in the most heartless of moments the pandemic struck. RBI pitched in with emergency liquidity provisions and loan repayment moratoria, besides a wide range of measures to fortify the banking industry. While the regulatory measures proved effective at accelerating bad-loan work-out rates and recognizing troubled assets, subsequent reforms helped address credit discipline, ensure responsible lending and improved governance.

In all, banks have written off Rs 10.57 lakh crore during the last five financial years, of which Rs 5.52 lakh crore was in respect of loans pertaining to large industries, the government informed the Parliament recently. As per RBI data, scheduled commercial banks (SCBs) have written off an aggregate loan amount of Rs 10.57 lakh crore and recovered Rs 7.15 lakh crore NPAs during the five-year period of FY19 to FY23.

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