What The Bank Write-Offs Tell Us About The Next Decade Of Growth

"Banks Wrote-Off Rs 10 Lakh Crore NPAs In Five Years" screamed headlines this week. Every year, the government discloses information on write-offs and bad loans during the winter session of parliament. And every year, without fail, there is widespread shock at the size of these figures.

Let's take a look at the numbers disclosed. Public sector banks alone accounted for Rs 7.35 lakh crore of the Rs 10.09 lakh crore in written-off loans.

Between April 2021 and March 2022, public-sector banks wrote off loans worth around Rs 1.15 lakh crore. At the end of FY22, gross non-performing assets for these banks dropped to Rs 5.4 lakh crore from Rs 6.16 lakh crore a year earlier, a net fall of Rs 76,000 crore.

So the reduction in bad loans largely came because banks were aggressively moving stressed accounts out of their balance sheets via write-offs.

As on June 30, outstanding loans to accounts classified as willful defaulters stood at Rs 2.76 lakh crore. Of this, the top 50 accounts added up to Rs 92,570 crore, according to a separate disclosure.

So yes, the outrage is not unjustified, and bankers do share the blame for acting too late and too little.

For example, in cases like Reliance Communications Ltd., where banks initiated a strategic debt restructuring scheme in June 2017, they essentially gave themselves and the promoters more time to figure out an alternative. The scheme eventually fell apart, and the company was dragged before the insolvency court, where it continues to linger for resolution.

But there is a case to be made in defence of the bankers. No banker truly wants to shut down an ailing large company. It invariably either controls important infrastructure, or ensures large-scale services to the population, or is a large employment driver.

Moreover, write-offs cannot be looked at as a mere whitewashing exercise. Banks have a specific timeline for the treatment of bad loans on their books. In the fourth year after recognition, they need to fully provide for the asset and write it off. Banks do this to get tax sops and to efficiently allocate the capital available to them.

But after that, bankers always claim that recovery efforts are on. The success there, though, is rather limited. While state-owned lenders have recovered bad loans worth over Rs 4.8 lakh crore in the last five years, recoveries from written-off accounts stand at a meagre Rs 1 lakh crore.

A History Of Low Recoveries

In the early 2000s, Indian banks—especially public sector banks—provided inflated loans to a group of corporates, without satisfactorily recognising risk, which is now well known. This caused the NPA mess.

The Reserve Bank of India's asset quality review in 2015-16 eventually forced a much-needed but delayed recognition of these bad loans. However, the tools developed to recover these loans were built at a time when nobody thought of such large-scale defaults.

As expected, the Securitisation and Reconstruction of Financial Assets and Enforcement of Security Interest Act of 2002 and its derivative in the form of asset reconstruction companies, were in no shape to deal with the deluge of bad loans.

Not just that, legal proceedings to attach borrower assets were met with long judicial delays by lower courts. That means borrowers had an incentive to delay, while banks had none to pursue defaulters.

The regulator's bad debt management schemes, such as corporate debt restructuring, strategic debt restructuring, and the scheme of sustainable structuring of stressed assets, too, allowed borrowers more time without addressing the core issue of recovery.

As a former banker, speaking on the condition of anonymity, explained, the system, including bankers, was too supportive of the defaulters.

A bad carpenter always blames his tools. But if you only have rusty tools available, the results will never be satisfactory, the banker said.

It was not till late 2016, when the government introduced the Insolvency & Bankruptcy Code that banks got their hopes up, another former banker said. The timely resolution, the removal of an errant promoter from the company, a legal mechanism to take tough decisions, and a clear distribution plan were all codified into the law.

It changed the lender-borrower dynamic, or at least promised to do it.

There were a handful of large, successful recoveries too, such as Essar Steel, Bhushan Steel, Binani Cement, Ruchi Soya, among others. But soon, the mechanism devolved owing to prolonged admission periods and slower decision-making at the National Company Law Tribunals.

For example, an insolvency case took 464 days in March 2021 to achieve resolution. The timelines have since expanded to 785 days (including any time deducted by courts) as of September 30, according to data collated by the Insolvency & Bankruptcy Board of India.

Now, more than ever, it is essential to have a legal system that is responsive and efficient when dealing with financial stress.

What's Changed?

Once again, the corporate credit cycle is reviving. As of October, non-food credit rose 18.3% year-on-year. While credit to retail segments rose 20% from a year ago, industrial loans were up 13.6%, with sectors such as engineering, metals, beverage & tobacco, cement, chemicals, and construction rising faster.

Is this fodder for the next cycle of bad loan formation? There is reason to believe that it is not.

For now, the RBI's decision to allow asset reconstruction companies to participate in insolvency proceedings as resolution applicants and diversify their funding base could potentially improve resolution rates. Its improved supervisory framework is also keeping a close watch on the financial strength of banks at frequent intervals to avoid a system-wide recognition like during the AQR.

Additionally, the government's decision to introduce a system to assign staff accountability for NPAs higher than Rs 10 crore may help in addressing any stray cases of malfeasance by the bankers. The government has also mandated a strong early warning system at public sector banks to monitor borrower quality on a real-time basis.

Lenders, too, are far better capitalised to take on any slippages in their pursuit of growth. They have the insolvency stick to scare the promoter enough for an out-of-court settlement. Most importantly, banks are more aware of their past mistakes. They are not only insisting on better borrower quality, but they are also not afraid of losing business because the loan application does not meet the necessary standards.

As the Indian banking system embarks on another corporate lending cycle, the ingredients are there for a stronger system to recover soured loans. Over the next decade, all eyes will be on how bankers, the regulator, and the government avoid the now-known unknowns.