Current and Legacy Problems in Public Sector Banks Explained.

Current Banking Scenario (2017).

What does financial stability Report June 2017 of RBI say ? (Just to inform you, RBI releases this Financial stability report Twice in a financial year. )

  1. During 2016-17, while deposit growth of scheduled commercial banks (SCBs) picked up, credit growth remained sluggish putting pressure on net interest income (NII), particularly of the public sector banks (PSBs).

Explanation – Owing to demonetization, banks deposits in saving accounts increased. This was not a happy moment for banks as banks need to pay an Interest to the customers depositing their money. Now FSP 2017, further says the Credit growth is sluggish. Particularly PSBs are not willing to provide more advances as they already have huge burden of NPAs on their shoulders. Let me tell you, when a loan goes bad, managers are held accountable for it. Managers involved in the lending are asked by auditors that how they came on a decision to lend a particular party. In order to escape from these rapid fire rounds of Questions, managers have become too shy to lend in Public Sector Banks. In a nutshell PSBs are having huge liabilities (deposits), compared to Assets (loans).

 

  1. The gross non-performing advances (GNPAs) of the banking sector rose but the stressed advances ratio declined between September 2016 and March 2017 due to fall in restructured standard advances.

 

Explanation – Kindly refer to previous post on types of Stressed assets of banks. http://localhost/trust-ias/stressed-loans-npas-restructured-loans-ever-greening-of-loans-written-off-loans/

Both NPAs and Restructured loans are part of stressed assets. Now because of risings burden of Stressed assets on Banks, Banks have stopped restructuring new NPAs as it causes Ever Greening of Loans.  so in simple words Stressed assets of PSBs are still high.

 

 

  1. Overall, capital to risk-weighted assets ratio (CRAR) improved from 13.4 per cent to 13.6 per cent between September 2016 and March 2017.

 

Explanation – The concept of “Capital to Risk Weighted Assets Ratio” came with BASEL NORMS

( BASEL NORMS – To be explained in a separate post).

 

Lets first understand The concept of Risk Weighted Assets

Banks provide loan to a range of customers. This involves from Governments, companies to Individuals. Loans given to the Government are usually safe as Governments don’t default on their repayments. But companies and individuals can default on their repayments. Thus due to a possibility of default by the debtors, banks face a risk called Credit Risk. Let’s take a simple example here. “Suppose XYZ BANK lends Rs.100 each to three different parties, then it’s Total Risk weighted Assets will be as following.

 

 

 

Customer of XYZ bank. Loan Amount. Risk Class (0%, 50%, 100%) Risk weighted Asset.
1.       Govt. of Goa. Rs.100 0% (as Govt. is most trustworthy customer.) Rs. 0
2.       Mohan lal & Daughters company ltd. Rs. 100 50 % ( Consider it a secured loan, i.e a mortgage based loan) Rs. 50
3.       Any Individual. Rs 100 100% ( Consider it as a  personal loan which is unsecured i.e no Mortgage is required) Rs. 100
4.       Total Rs. 300 Rs.150

 

This means, on a total loan of Rs.300, bank XYZ has a Total Risk weighted asset of Rs.150.

 

Now understand the Capital in Capital to Risk Weighted Assets Ratio (CRAR).

Banks usually has different Categories of money with them.

  1. Deposit money – As explained already, this is liability on a Bank. This money is used for lending but if customers come and ask for their deposits, then it is the duty of bank to pay it back.
  2. Owner’s money– Also called as Equity Capital/Tier 1 This capital comes from the holders of ownership rights of the Bank ( i.e share holders of bank).
  3. Leverage or Debt Money – Also called Tier 2 Capital. Even a bank has to take Debt from other Banks or from any other financial Institutions for its smooth functioning.

 

Now here in CRAR, “the capital”  mentioned should be a combination of “Owners Money” and “Debt money”, conveniently called as Tier 1 and Tier 2 Capital respectively.

 

Lets Summaries, Suppose Capital to Risk weighted asset of XYZ Bank is 13.6%. Then XYZ is maintaining a Capital of Rs. 20 (13.6% of Rs.150) in a combination of Tier 1 and Tier 2 capital form.

 

 According to BASEL III norms, Banks are to maintain CRAR of 8%. So we are doing fine in the CRAR parameter as Indian Banks are maintaining CRAR at 13.6% in 2017.


 

Legacy Problems with Public Sector Banks in India.

  1.   With continuous expansion of Branches in remote areas, Priority Sector Lending, maintenance of higher reserve ratios (Cash Reserve Ratio or Statutory liquidity Ratio), Loan Waivers in Agriculture etc. had its impact on the profitability of the banks.

 

  1. The present era of competition has witnessed various large multinational banks like American Express, HSBC, City Bank, etc. and other multinational banks coming very aggressively. The new banks have set the tone and to an extent also the standard for technological improvements with product innovations. So, PSB have to run in a market which has no geographical barriers and will have to develop abilities of product innovation as well as delivery comparable to the best in the world. That is why Banks Consolidation has been advised by various committees like Narsimham Committee or P.J. Nayak Committee.

 

  1. BUREAUCRATIC INTERFERENCE Another very important reason for the plight of the customers of PSBs is the bureaucratic set-up within the banks whereby it takes months together to get the loan sanctioned. By the time loan gets sanctioned, the project cost gets escalated giving rise to defaults in the payments by the organization and ultimately bank is forced to have larger NPAs in their hands. Being Government owned, these banks are politically led. Political agenda tops at the cost of bank’s profitability and stability. Political interference in delaying credit installments to bank and channeling of bank funds are common features giving rise to NPAs. Political motives have led to the problem of overstaffing in the banks. All those and much more have paralyzed Indian public sector banks and means to come out of this glut is not very easy. Narsimham committee report suggested Government to cut its Shares holding in PSBs below to 49%. Not much has been done on this suggestion.
  2. Strong Trade Unions – Another important challenge is that the growth of trade unionism in banks; resulting in frequent strikes, lockouts, conflict amongst the management and employees leading to loss of both the consumer as well as the banks. These strikes have the roots in dissatisfaction of workers on the basis of non-fulfillment of promises, faulty appraisal system and absence of accountability in the system. This leads to the rise of total NPAs of the scheduled commercial banks. This requires the improved credit skills for appraisal of credit proposal and monitoring the loss.

About the author: Aman Kumar

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