Bad loans have been the deeper malaise of public sector banks which have inflicted deep wounds on Indian growth story. Narendra Modi government inherited this problem in legacy but has since got worsened. As the economy surged in the second half of the last decade, public sector banks (PSBs) opened their purses for the corporate sector without having adequate manpower who can assess the risk associated with those loans. The economy started shrinking once the UPA government went on to control spiralling double-digit inflation through fiscal and monetary management. Falling growth and rising interest rate compounded the problem of bad loans as these loans had corruption component too. The PSBs, which account for 70% of our banking system and almost 90% of bank NPAs, were happily ever-greening bad loans of influential, politically connected promoters via technical adjustments. The infamous corporate-political nexus worked in full swing.

For a banking sector whose problem got compounded with bank frauds of Nirav Modi and Mehul Choksi, Tata Steel’s acquisition of Bhushan Steel offers a ray of hope. Tata Steel’s wholly-owned subsidiary Bamnipal Steel Ltd (BNPL) has announced the completion of its acquisition of Bhushan Steel, marking the resolution of the first case under the Insolvency and Bankruptcy Code (IBC), 2016. In the first round, RBI referred 12 cases to the IBC totalling about 25% of the gross NPAs in the banking system. According to banking industry sources, 28 more accounts were referred to the IBC. In most of these cases, the process is underway.

The most important aspect of the agreement is that banks will receive Rs 35,200 crore immediately, which covers most of the principal amount Bhushan Steel owes to its lenders, besides a 12% stake in the company. The cash payment immediately lessens the burden on a group of banks including fraud-hit Punjab National Bank (PNB). This resolution gives a hope to the banking sector, neck-deep in bad loans, that a recovery of money is actually possible when via the IBC route.

On IBC, the big question that has been repeatedly asked is whether there will be enough buyers for distressed assets.  The other question being asked is whether the NCLT, the body which deals with IBC cases, have adequate infrastructure to deal with a large number of insolvency cases? Right now, there are about 25,000 pending cases with the NCLT. If the NCLT doesn’t have enough manpower and institutional infrastructure to deal with these cases, hopes of faster resolution of NPA cases may not be realistic.

Ten months after they were first shortlisted by the Reserve Bank of India for immediate referral for bankruptcy proceedings, four of the 11 large corporate accounts are now in the final stages of resolution. In cases like Amtek Auto Ltd., Electrosteel Steels Ltd., Jyoti Structures Ltd. and Monnet Ispat & Energy Ltd., the committee of creditors has approved resolution plans that they think will work best. These cases are now at the National Company Law Tribunal, waiting for a final nod before the resolution plans can be implemented. From London-based Arcelor Mittal, Korea’s POSCO, Blackstone, TPG Capital to domestic biggies like the Tata Group, Mumbai-based Shapoorji Pallonji Group, Ajay Piramal-controlled Piramal Enterprises and Sajjan Jindal’s JSW Steel, there is now a good line-up of interested buyers for the stressed assets/companies referred to the NCLT under the insolvency process.

A lot of hope is pinned on the Insolvency and Bankruptcy Code (IBC) to provide the much-needed cure to all the ills in the banking system. But the main issue is how are banks going to play the insolvency game. Rather than holding on to stressed assets in their balance sheets, will they be ready to take big haircuts? The grapevine in the market is that many prospective buyers are looking for an average 50% haircut in large cases. All eyes are on banks to see if they would take the plunge and accept the haircuts.

Of course, the buyers’ response has been good only for large corporates. There are few takers for small and medium companies. Going by the recent case of resolution at Murli Industries, banks had to settle for as high as 75% haircut, which is not a happy situation for the lenders. However, the quantum of haircuts was more a function of specific cases. High haircuts may be reflective of lower economic value and viability of the businesses being referred, rather than it being a reflection of the IBC process.

The resolution of Bhushan steel gives hope as the amount locked in this company was almost 5% of total reported gross NPAs. It is important now to chart out the exact amount of GNPAs in the system and the worsening records of the recovery process.

The gross non-performing assets (NPAs) of all the banks in the country amounted to Rs 8,40,958 crore in December 2018 of which loans to industry were almost at Rs 6,09,222 crore, accounting for 20.41% of the gross advances. In India, the total outstanding amount for top 50 stressed borrowers, funded by scheduled commercial banks, stood at 3,72,379 crore as on September 2017, according to the RBI. But if we believe former RBI deputy governor KC Chakraborty, the total chunk of all problematic loans in the banking system would be around Rs 20 lakh crore.

Bad loan records of only four countries which belong to PIIGS group are worse than India. In the second quarter of 2017, Greece with 36.37%, Italy with 16.35%, Portugal with 15.52% and Ireland with 11.85% had worse stressed assets. The four major economic drivers in the developed world, UK, US, Japan and Germany had NPA ratios less than 2%. Within the emerging market economies (EMEs), China, Argentina and Chile had low ratios of between 1-2%. Brazil and South Africa, which are part of the BRICS Group of nations, had moderately high ratios of 3.69% and 2.83%, respectively.

To compound the problem, banks’ loan recovery record has been extremely poor. To be more specific, over a roughly three-and-a-half year period, from when Narendra Modi took charge as Prime Minister in mid-2014 to the end-December 2017, PSBs have written-off loans worth Rs 2,72,558 crore. Of the amount, a meagre Rs 29,343 crore has been recovered, according to data available with the central bank. In an indication of deteriorating management of non-performing assets (NPAs), the rate of recovery of banks’ gross NPAs has been steadily declining for the past 12 years and hit the lowest level of 20.8% in 2016-17. “Recovery of banks’ NPAs remains poor, has declined to 20.8% by end-March 2017 from 61.8% in 2009,” the RBI said. After peaking in 2009 and remaining well above 40% in the earlier years, the recovery rate has declined over the years, the data show.  Out of Rs 2.86 lakh crore worth of bad loans being chased through DRTs, SARFAESI and Lok Adalats, banks were able to recover Rs 28,000 crore worth of loans in 2016-17. In the previous financial year, the banks and financial institutions could recover Rs 22,800 crore worth of bad loans out of total Rs 2.21 lakh crore being chased through these legal channels. The resolution of these loans is definitely a big task due to systemic hindrances and a long list of wilful defaulters. But they demand urgent action.

While the winds of faster growth recovery have blown throughout the world, the growth in the Indian economy has been subdued due to mainly banking sector problems which have resulted in slower credit growth. In an economy like India which creates one dollar of nominal national income with one dollar of credit growth, we can hardly afford slow and lopsided credit expansion. In FY18, as per Reserve Bank of India data, credit growth was at 8,29,187 crore but in the last fortnight of FY18, banks seem to have gone all out to disburse credit. Credit disbursed during the fortnight jumped by 2,79,361 crore. That is, almost 34% of the credit in FY18 was disbursed in a single fortnight. The RBI and government must look at this phenomenon seriously and try to resolve it.

The history of capitalism does indicate that bad problems do get compounded when the economy enters in recessionary phase but the resolution becomes easier with faster growth. Our economy has been in recessionary phase since FY12 and the recovery has been only temperate. The government must try to resolve systemic problems by changing the ownership and managerial structure of these banks but the focus must be to attain higher growth. The growth is the panacea of many ills of our economy including the bad loans malaise.