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Date:08/09/2003 URL:

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Bad loans of banks: Causes and remedies
The absence of proper bankruptcy laws and the dilatory legal procedures in enforcing security
rights are the root cause of bad debts in banks.
BAD AND doubtful debts of banks, called non-performing assets or NPAs in banking jargon,
have been attracting wide attention for varied reasons. Some of the reasons for the burgeoning
NPAs are: Bank officers do not know how to lend and are also corrupt.
A major portion of bad debts arose out of lending to the priority sector, at the dictates of
politicians and bureaucrats. If only banks had monitored their loans effectively, the bad debt
problem could have been contained, if not eliminated.
The top managements of the banks were forced by politicians and bureaucrats to throw good
money after bad in the case of unscrupulous borrowers. Many big borrowers defaulted only due
to the recession in the economy. The absence of proper bankruptcy laws and the dilatory legal
procedures in enforcing security rights are the root cause of bad debts in banks.
These and similar views are freely expressed by knowledgeable people in the field. All the above
statements have some elements of truth. It is like six blind persons looking at an elephant and
describing its physical characteristics. Unless the problem is identified properly, no remedial
action is feasible.
First, the facts. The total NPA of all scheduled commercial banks in India had swollen from Rs.
47,300 crores to Rs. 70,904 crores during the five years from March 1997 to March 2002, as
per the Reserve Bank's annual reports on trends and progress of banks in India.
Against these, banks had provided for Rs. 35,358 crores or roughly half the total by 2002. Still,
the net NPA was as high as Rs. 35,546 crores and represented 5.5 per cent of the total
advances; this is high compared to around 2 per cent for banks in advanced countries.
A redeeming feature
One extenuating feature for Indian banks is that the NPA amounted to a mere 2.3 per cent of
total assets. This is because advances comprise less than 50 per cent of total assets, with the
banks having invested heavily in government securities in India. With banks required to keep their
own capital and reserves at a minimum of 9 per cent of the advances portfolio, the NPA level is
not such as to cause concern about the health of the banking system.
Perhaps a few weak and adventurous banks could be threatened with insolvency, but the system
as a whole does not appear to be financially vulnerable.
Let us now examine the reasons for the higher levels of NPA in Indian banks. At the outset, it
has to be admitted that no bank can have zero NPA. Any business, and more so banking, does
involve risks and one should learn proper lessons from the past. Incidentally, the Chettiar
community of Tamil Nadu, who were pioneers in overseas trade and commerce, had recognised
this basic principle long ago.
When their young males were sent to do business abroad, there were losses in the initial years.
Legend has it that the fathers in India will write the losses to an account called `Budhi Kolmuthal'
or `Intellectual Capital' or `Capital for Experience'. Alas, the mandarins in Government expect
the banks in the public sector to totally avoid NPAs and thereby engender counterproductive
action among bankers.
Wrong lending decisions
One of the primary reasons for NPA could be that the lending decision was, ab initio, incorrect.
Seasoned bankers would scoff at this as a preposterous statement, but the reality has to be
faced.
A major portion of bank lending is to industries and trade; this segment accounted for over 53
per cent of gross bank credit, excluding loans to food procurement agencies of governments, as
at the end of March 2002, vide RBI data. In lending to these borrowers, bankers have to relearn
a lot.
Till the early 1960s, bankers lent only to traditional companies owned by "respected" business
groups and relied primarily on the credentials of the group. The emergence of small scale
industries and the gradual opening up of the economy changed the scenario with many new
entrepreneurs on the scene and bankers had to learn newer ways of assessment and appraisal.
In 1974, an expert committee under the chairmanship of Prakash Tandon rewrote the policies
and procedures of lending to industries by banks. These were implicitly followed by all banks
under the directions of RBI. While the `norms' prescribed by the Tandon Committee were
appropriate for the conditions in 1970s, banks were following them even after 20 years.
In the late 1990s the RBI freed banks from the shackles of the norms, but banks are yet to get
out of their reliance on norms and arithmetical formulae and, instead of understanding and
interpreting the numbers judiciously, they converted a tool into a talisman.
Appraisal of credit needs of industrial units and business concerns cannot be put into a
straitjacket and banks have to relearn the tricks of the trade.
At present, either they deny needed credit to small and medium enterprises because of the norms
or go overboard in relation to their bigger customers who enjoy "corporate loans" at ridiculously
low interest rates at 5 to 6 per cent p.a. In their obsession with financial data, bank officers do
not seem to probe vital aspects such as the need for and the purpose for which credit is needed.
Low level of expertise
Another factor that can contribute to the low level of expertise in many big public sector banks is
the constant rotation of duties among officers and the apparent lack of training in lending
principles for the loan officers.
Being dictated to by the bureaucrats in the Government, public sector banks are asked to frown
upon specialisation of officers in any particular branch of banking; this also makes it hard for
developing a fully trained cadre of lending officers.
If the public sector has to compete in the fierce financial markets, they have to create and nurture
a good cadre of officers in various disciplines. Corruption, as a cause for NPA, is, in the author's
opinion, not a serious one. The number of officers who are not scrupulously honest will not be
large in banks; in any case, unlike government departments, banks are not monopolies in
rendering service and customers will not tolerate undue levels of corruption.
Many among the intelligentsia, who belong to the service class, still believe that the priority
sector, comprising the small trader, industrialist and the farmer, is responsible for the NPA
problem.
This arises from the notion that such small people are either more dishonest than the larger
borrowers or are more prone to business failure. While a small business/industry/farmer is more
susceptible to recessionary conditions in the economy, they are certainly not more dishonest than
the bigger ones.
(To be concluded)
R. Viswanathan
(The author is former
Deputy Managing Director,
State Bank of India).
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