MSME loan freebies, and the NPA fallout

Another huge build-up of NPAs is round the corner, even as it may not show up in the books of public sector banks this fiscal

The idea of loan melas is disruptive and the present thrust being provided to the SME sector through the banking channel can cause a bit of worry. The steps that have been spoken of are in the form of widening the reach of banks — especially those in the public sector — to ensure that there is better flow of funds.

Besides the setting of targets to be met by the banks, there have been announcements of one-time settlements for such loans, and not calling missed payments as NPAs (non-performing assets) till March 2020. The concern to alleviate their problems is palpable, considering that this sector has been adversely affected on account of both demonetisation and the implementation of GST. There are also schemes such as loans to be sanctioned in 59 minutes and special trading portals. In this context, it would be instructive to examine how these assets have performed.

Adversity in lending

The top six banks in the public sector (SBI, BoB, PNB, Canara Bank, Bank of India and Union Bank) and private sector (ICICI, HDFC, Axis, Kotak Mahindra, IndusInd and YES Bank) have been considered for this analysis. The table provides information of NPAs of these banks in both the priority and non-priority sectors for FY19.

The table shows that the private sector banks had a better NPA ratio compared with their public sector counterparts, the former’s being a little over half of that of the latter. The ratios across both the priority and non-priority sectors are interesting, as they present different pictures.

In the case of priority sector, the PSBs had a distinctly higher NPA ratio of 10.04 per cent as against 2.04 per cent for private banks. Clearly, this difference has got a lot to do with the choice of customers as well as the mindset of borrowers. Across all priority sector segments barring personal loans, PSBs had double-digit ratios with the peak being in the industry category at 16.5 per cent. This refers to the SME lending or MUDRA loans which come under priority sector lending.

For services, which would once again primarily be by the SMEs in this segment, the ratio was 10.6 per cent. The private banks had much lower numbers of 1.5 per cent in industry and 1.56 per cent in services. Therefore, there has clearly been a case of adverse selection which can be attributed to an extent to the nudge provided from above, which is missing in the case of private banks, where the decisions are taken based more on commercial considerations. Also, the PSBs have to take responsibility for not appraising potential customers in an efficient manner.

There is also the case of a moral hazard that has permeated the borrowers, especially in agriculture, where the prospect of a farm-loan waiver gives an incentive to delay payments. This explains why the ratio is higher at 11.36 per cent for PSBs as against 3.78 per cent for private banks. While the former may be faulted for lower level of due diligence when disbursing credit, the pressure from above cannot be ruled out, especially as there has been relentless pressure on public sector banks to meet targets to provide support to this sector.

The same does not hold for private banks, which do similar kind of lending mandated by the priority sector norms and are able to manage a cleaner portfolio.

Declaring assets

The non-priority sector NPA ratios for the two sets of banks present a contrasting picture. In the case of PSBs, the ratio is lower than that for the priority sector even though for industry, the ratio remains above 15 per cent as against the 8.89 per cent of private banks, which is relatively lower, but still high nonetheless.

This can be attributed to the fact that after the AQR (asset quality recognition) was introduced by the RBI, the PSBs went on a massive clean-up operation and these assets came to the fore. They had larger exposures to sectors which got embroiled in controversy — such as steel, power, mining and telecom — which subsequently went through the CDR process before landing in the IBC net. For the private banks, this scenario came with a lag; which is why for some of them, the NPAs to industry in particular have risen of late.

Interestingly, in the case of personal loans, the NPA ratios for the PSBs, though low, have been higher than those of private banks. This means that there is scope for them to improve their credit appraisal systems, which will mean reskilling as the retail segment has become progressively more important and the regulators — the RBI and SEBI — are working towards moving long-term funding to the corporate bond market.

Also, with the new external benchmarking system that came in force from October 1 for SMEs and retail customers, the market risk originating from re-pricing periodically would pose a challenge. When it comes to SMEs, the risk would double as they would also inherently be more vulnerable to turning into NPAs.

Future risks

What does this mean? The present overdrive to bail out the SME segment through various banking measures is fraught with a big risk of enlarging the NPA size, especially for PSBs. As banks do not have to classify them as NPAs for missed payment this year, the numbers to be presented for FY20 may not present the right picture for both manufacturing and services. This can also cause bunching in the subsequent year, when the NPAs are recognised.

All this will mean that the stability that may have been achieved in these ratios for banks may be ephemeral. And as PSBs are finally owned by the government and therefore have to pursue common goals, greater care has to be taken when disbursing loans as they are more vulnerable relative to private banks.