RBI deputy governor Anand Sinha recently said that from 15% (of total loans of the banking system) the NPAs came down till 2008, but they have risen sharply by 91% or Rs46,670 crore between 2005-2006 and 2010-2011. The situation is serious and banks had better do something about it quickly

When one of India’s senior most central bankers describes a situation as “not alarming”, do we take him at face value and relax? Or is he talking bankers’ double-speak, which needs to be translated as “the situation is serious and all of us had better do something about it quickly?”

Take for instance the speech of Anand Sinha, deputy governor of the Reserve Bank of India (RBI), at the fifth Mint Annual Banking Conclave in Mumbai a few days ago.

Mr Sinha warned anyone who would listen that the non-performing assets (NPAs or bankers’ long-hand for bad debts) of the banking system had risen beyond the comfort zone.

“The situation is under control but there is an underlying reality that is not very comfortable”, he said. Backing up his statement with figures, Mr Sinha said that from 15% (of total loans of the banking system) the NPAs came down till 2008, but they have risen sharply by 91% or Rs46,670 crore between 2005-2006 and 2010-2011.

In a related development, State Bank of India (SBI), the nation’s largest bank, said that its bad debts rose to a record Rs40,098.43 crore in the December 2011 quarter. “Not alarming”? No bells ringing in RBI or SBI headquarters?

Mr Sinha explained the spike in bad loans thus:

“A boom in economic activity preceded the world economic crisis set off by the sub-prime lending in the United States. During the period of fast expansion, the banks lent ‘aggressively’ to industry and the corporate sector.

But they were not careful about the entities to whom the lent huge amounts. Monitoring of loans was lax; the banks did not look too closely at how the borrowers were spending the loans, where the money went, whether it was siphoned off to be used in activities that had no relation to the purposes for which the banks had lent money. The banks would have kept a close watch on the borrowers and the funds trail if they had “done proper due diligence” (what an ugly phrase; can’t they find a more elegant way of putting it?).”

Mr Sinha admitted “due diligence” had been largely ignored. Hence the banks suddenly found a mountain of bad debts blocking their way.

Automation was also what the bankers would describe as the “villain of the piece”.

A loan becomes a bad debt when the borrower delays payment of interest or loan instalments beyond 90 days.  In the “bad old days” of about a decade ago, the missed instalments were recorded manually i.e. clerks wrote in the big ledgers that borrower X, Y or Z had delayed payment beyond the deadline of 90 days.

The manual system was replaced by an automatic, computerized system which, like time and tide, waited for no man: it identified a bad loan as soon as a borrower delayed payment beyond 90 days. Therefore, NPAs were identified more quickly and showed up in large numbers in the books.

More often than not, bankers and bureaucrats play down a crisis. This may be the case with Mr Sinha’s analysis of bank NPAs. For it is a crisis, notwithstanding Mr Sinha’s “not alarming” diagnosis.

For instance, Mr Sinha said bad loans were rising despite write-offs. Banks are given limited powers to write off loans, allowing the borrowers to go their merry way without paying back the loans.

Also, the ratio of actual recoveries to total creation of NPAs was 40.74% in 2008. The ratio plunged to 28.74% in 2010.

Mr Sinha however consoled himself, and hopefully the nation, by quoting from the Financial Stability Report of the RBI. The report showed, according to Mr Sinha, “that even with 40% of restructured advances turning NPAs, the banking system will not collapse.”

Thank you, Mr Sinha, that is reassuring. But do we have to wait for the collapse? Can’t you do something to reduce bad debts to an irreducible minimum? If you do so, banks will be able to lend more to industry. And this time, hopefully, due diligence will get more importance.

The seriousness of the crisis was underscored by a letter, reported in the newspapers, from the finance ministry that rapped several public sector banks on their knuckles. It warned the banks that they had not set aside thousands of crores to cover loan defaults. Therefore the banks had overstated their profits.

In one bank, under-provisioning for bad loans was in excess of Rs5,000 crore over the last three years. If the banks had set aside funds in line with RBI rules, they would have reported losses, the ministry said.

Like Nero, is someone fiddling while Rome burns?

(R Vijayaraghavan has been a professional journalist for more than four decades, specialising in finance, business and politics. He conceived and helped to launch Business Line, the financial daily of The Hindu group. He can be contacted at [email protected].)