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Asset quality compulsions

The big news from the quarterly results of banks that were released last week was the sharp improvement in State Bank of India’s (SBI’s) asset quality. For quite some time, this indicator had been negative, subjecting the bank’s management to continuous criticism. In the fourth quarter of 2013-14, this trend seems to have reversed, with gross non-performing assets (NPAs) dropping by 0.8 per cent and net NPAs by 0.7 per cent. Profitability was still adversely impacted by the provisions made for these assets, but if the decline is repeated in the subsequent quarter, it could signal a real bottoming out of the business cycle. This reassurance has to be tempered, of course, with the fact that the year 2013-14 as a whole has been quite bad on this front. For 36 banks (including SBI) that have reported results so far, gross NPAs rose by a striking 36 per cent during 2013-14 over 2012-13. Thus, this is a burden that the system will have to deal with for a while, which would constrain the ability of banks to raise capital to support credit growth in line with the new prudential requirements.

This problem could become a huge hindrance to reviving growth. Every major stakeholder has a role to play in solving it. For banks, there are lessons to be learnt from the large and rapid build-up of bad assets. A significant part of this may have been the result of forces out of their control, but to the extent that the slowdown in growth caught them napping, there is an argument for improving internal risk monitoring and mitigation systems. SBI seems to have had some success on this front. The question is: are other banks making the necessary efforts? Future credit growth must take place in the context of state-of-the-art risk management frameworks.

For borrowers, at least many of the large ones, the recent surge in equity markets provides an opportunity to de-leverage their businesses. If market buoyancy persists, attractive valuations should induce them to issue more equity to the public without necessarily compromising control. Whether promoters who run their businesses into the ground should continue to exercise control is itself a question, but a separate one. For the government, the challenges lie at both the macro and sectoral levels. For the economy as a whole, the best response to the NPA problem is to do whatever is needed to get a recovery going. This will contribute to reducing NPAs directly as well as indirectly, through expanding opportunities for de-leveraging. At the sectoral level, the most significant external factor responsible for the NPA build-up is stalled and unviable infrastructure projects. The government must begin to push for the completion of as many projects as possible, which will help banks repair their balance sheets with respect to these exposures. But, more importantly, the financing strategy for large-scale infrastructure investments needs to be reworked. Alternative channels for long-term finance, both market and institutional, need to be developed quickly.

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