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Asset Quality of Indian Banks: Way Forward (Shri N. S. Vishwanathan, Deputy Governor - August 30, 2016 - at National Conference of ASSOCHAM on “Risk Management: Key to Asset Quality”, New Delhi)

News and Press Release - Dated:- 8-9-2016 - The Indian banks in general, and the Public Sector Banks (PSBs) in particular, are grappling with the huge stock of stressed assets that has piled up in the system over the years. Any amount of discussion on the whys and what of stressed assets would therefore never be enough, if it enables us to discern what led to this phenomenal build-up of non-performing assets (NPAs) in our system and determine what we should do to solve them, and identify what co .....

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if you have heard this many a time, let me put the issue in perspective in terms of the magnitude and dimensions of the problem (Chart 1 and 2). The total stressed assets in the Indian commercial banks have risen to 11.5% with the Public Sector Banks leading the strain at 14.5% as at end-March 2016. They still contain some amount of restructured assets indicating potential for some more pain, albeit of lesser intensity. Incremental NPAs Let us now look at the year- on- year accretion to the NPAs .....

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e with the PSBs facing greatest strain across most sectors (Chart 5). Restructured assets During the five years to March 2015, banks have resorted to restructuring of loans in many cases to postpone recognition of non-performance, or what we now call extend and pretend , rather than using it as a tool to preserve the economic value of the units as intended. As a result, until 2016 the restructured assets constituted more than 50% of the stressed assets of all scheduled commercial banks masking t .....

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ls of NPAs have been progressively causing increasing stress on banks earnings. As a result, banks provisioning capacity has also come under pressure leading to a spike in the Net NPAs levels as well (Chart 7). Higher net NPAs indicate lower provision coverage ratio which should progressively improve as the strain on profitability eases. Some contributory factors The reasons for the growth in the NPAs are also not far to seek. Table 1 and the Chart below show that the bank debt fuelled the rise .....

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2014-15 2015-16 GDP Growth (%) (Annual) 9.6 9.3 6.7 8.6 8.9 6.7 5.6 6.6 7.2 7.6(P) Credit Growth (%) (annual- As reported on the last Friday of the financial year) 28.1 22.3 17.5 16.9 21.5 17.0 14.1 13.9 9.1 10.9 Credit growth Industrial sector (%) 26.7 25.0 23.0 24.4 23.6 20.3 15.1 13.1 5.6 2.7 Portfolio diversification is key to managing idiosyncratic risk. The banks credit portfolio leaves scope for improving the diversification both in terms of single name and sectoral concentrations. Charts .....

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ook. Let me therefore examine the elements of a good credit risk management, look at the past and draw some lessons for the future. Banks are in the business of taking risks. If they are not taking risks they are not doing banking business. But, what does taking risk mean? Can it mean taking chances? When would a measured risk taking be different from recklessness? Essentially, risk management would involve knowing the risk, measuring it, and controlling it within the risk appetite of the bank b .....

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ternal factors might render the projections unachievable. The usual way to deal with this is to do a sensitivity analysis. The scenarios tested should be adequately stressed and plausible. They need to factor in the possibilities that arise on account of the fact that India is a lot more open economy now. Competition from abroad apart from domestic competition should be visualised and therefore global capacities and not just domestic capacity should be the criteria. Banks very often also undermi .....

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the game. What this does is to turn the problem of corporate insolvency into a problem of the banks rather than that of the promoter. Therefore a strong underwriting system that is properly steeped in understanding and mitigating risks is the first element of credit risk management. But when would this happen? Only when risk culture permeates across the bank. Spreading risk culture is the function of the board and top management of the bank. In fact the Basel Committee states as under: Banks sh .....

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ystematically address them. We have allowed banks to have an exposure up to 15 percent of their capital to a counter party and 40 percent to a group. Banks must be wary of hitting these limits. Seven exposures of 15 percent each would make the bank s capital vulnerable to the fortunes of a few companies. There is therefore a move to look at these limits differently. The linkages will not be through ownership alone but also economic relationships. An effective pre-disbursement control is a very i .....

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g can be made up by a strong post-sanction supervision and an excellently appraised credit can be marred by poor monitoring. Let me elaborate. Assume that the cost of setting up the plant was overestimated and passed off in appraisal. Tight control on release of monies and strong on-site supervision can still mitigate the risk. On the contrary, a lax post-sanction supervision can lead to the promoters not bringing in their contribution in time, money being used for purposes not part of the proje .....

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large loans became fashionable to a default that we had to finally put a stop to it. We realise that in any part of the world a going concern is better than a gone concern and it is more so in our country in the absence of a framework for dealing with insolvency. Hopefully, this will be overcome shortly, now that the Insolvency and Bankruptcy Act has been passed. But we are not clear why a bank cannot classify an account as NPA and still provide need based credit. The system of restructuring to .....

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ence in football game. In football, it is the front line forwards and mid-fielders who set the stage for winning the match. If they play with caution and strength, the rest usually follows smoothly. In credit risk management, the loan officers and the loan sanctioning authorities constitute the first line of defence. Being responsible for operational management, they have ownership, responsibility and accountability for assessing, controlling and mitigating risk in credit exposures together with .....

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ond line of defence has multiple roles. It has to keep a watch on how the forwards are progressing and whether they need to call them to modify the strategy. At the same time they have to be in readiness to react should the situation suddenly slip out of the forwards control. But, it would never be advisable for them to leave their place and join the forwards - this would expose the team to attack by the opposite team. Thus, the second line should only reinforce what the first line is doing, not .....

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ide assurance to the organisation s board and senior management on how effectively the organisation assesses and manages its risks. They particularly look into the manner in which the first and second lines of defence operate. The assurance task covers all elements of an organisation s risk management framework, i.e. risk identification, risk assessment and response to communication of risk related information. Comparing this with a football match, one would not expect the goalkeeper to be runni .....

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utional mechanisms have to function, they must be put in place to play the expected role and not just as a tick box compliance. The multiple defence line model would not be effective in the following situations Misaligned incentives for risk-takers in first line of defence, which primarily arise from the emphasis on generating sufficient revenue and profits for the institution. Lack of organisational independence of functions in second line of defence. Lack of skills and expertise in second line .....

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to each player and group of players. They are thus like the coach and the manager of a team. Mind you, if you look at famous football leagues, the coach and the manager are an important part of the teams. Consequences If banks continue to remain saddled with huge NPAs for a long time, it would make them risk averse and choke the lending for economic activities in general. Another consequence is the likely shift by the PSBs to loan segments such as personal loans and housing loans where the banks .....

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ver, these banks will have to manage the resultant credit concentration risk well. Overall, dealing squarely with stressed assets is crucial for the nation s economic growth, which is why the RBI and Government have taken several measures in this direction. The Government and RBI Tool Kit Steps taken by Government The consequences of default in loans are aggravated by poor recovery. In particular, the low rate of recovery through legal recourse is a cause for concern - the annual recovery as per .....

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time span. The Government has also taken steps to improve the corporate governance of the PSBs. The Indradhanush initiative - breaking up the post of Chairman and Managing Director, strengthening board and management appointments through the Banks Board Bureau, decentralizing more decisions to the professional board and finding ways to incentivize management - would contribute to better performance of loan portfolio of banks. The Government has also pumped in quite a bit of capital into the bank .....

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base is accessible to all the banks. That database allows banks to identify incipient sickness that is reflected in repayment behaviour. Leveraging the CRILC database, lenders could coordinate their planning for recovery and resolution of the affected unit through a Joint Lenders Forum (JLF) once early signals of sickness are noticed. Incentives have been given to banks for reaching quick decisions. We have taken steps to ensure that the forum performs efficiently. RBI s regulations require bank .....

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We have been constantly monitoring the performance of the scheme and tweaking it wherever necessary to ensure that it is not misused to evergreen the weak loans and to iron out the wrinkles if any. The SDR scheme has been designed to deal with problem loans where promoters need to be replaced, whereas the Scheme for Sustainable Structuring of Stressed Assets (S4A) is an optional framework for the resolution of large stressed accounts without change of promoters. The S4A envisages determination o .....

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are designed to provide protection against system level stresses. In particular, the countercyclical capital buffers and expected loss based provisions would strengthen the banks and create sufficient cushions against systemic risk events. The essence of all the macro-prudential and countercyclical elements of Basel III is that they encourage banks to save capital in good times for use in bad times. For Indian banks, the stress has occurred before full implementation of Basel III and to that ex .....

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necessary that the stressed assets-build up is contained and the banks get back to generating adequate internal accruals. We are hopeful that, once the pain is over, banks would emerge much stronger. Malfeasance While the RBI believes that businesses can get into financial difficulties and genuine business needs should be supported, malfeasance should be properly dealt with. We have, therefore, put in place a detailed system for identifying wilful defaulters and non-cooperative borrowers with at .....

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