Healthy condition of the banks is very essential for a well-oiled economy and strong economic growth. Indian banking system has recently come under the spotlight due to a significantly high percentage of NPAs. RBI has been assiduously working along with the Government and the banks to resolve the NPA problem. Recently RBI also identified 12 insolvent accounts, which are responsible towards 25% of the NPAs of Indian Banking system. These accounts will immediately be referred to Insolvency and Bankruptcy code for resolution. The move is laudable as it will help banks to focus their energies on specific accounts to recover their money. However, it is equally important to understand the root cause of the NPA problem so that the banking system is better prepared for any such situations in future.
One of the notable things about the insolvent accounts contributing to the stressed assets is that these primarily belong to Infrastructure and manufacturing sector like Power, Telecom, Transportation, Aviation, Steel and Textile. As per the Financial Stability report by RBI in December 2016, Infrastructure, Metals and Textile contribute the maximum towards the stressed assets.
Projects undertaken by companies in these sectors are typically long gestation and linked to economic cycles. The very nature of projects makes it unsuitable for commercial banks to lend to these projects as banks depend upon short term deposits to fund them. According to Report on Trends and Progress of Banking in India 2015-16, almost half of the deposits and borrowings of the banking sector were short term in nature as of March 2016. Further long term assets financed by short-term liabilities showed an increased in 2015-16. This presents Asset-Liability Mismatch (ALM) risk for the banking system. These projects are best funded by Financial Institutions that have access to patient long-term capital. India has a long history of specialized long term financing institutions from IDBI, IFCI and ICICI to newer financing vehicles like Infrastructure Debt funds and Infrastructure Finance companies. Some of these institutions morphed into retail banks while others vehicle could not take off as expected. Globally also specialized development financial institutions take up the role of funding long-term projects. For example, China Development Bank (CDB) played a critical role in infrastructure development not only through capital contribution but also enables capital to flow into the long gestation projects by providing technical assistance, risk mitigation, credit support and risk mitigation instrument for projects.
Given the magnitude of funding requirement to sustain India’s growth rate for next few decades we surely need to have differentiated institutions for long term financing of infrastructure and various other sectors. The current banking system has neither sufficient capital nor the capacity to fulfill the needs of India’s economic growth. RBI took a great first step in this direction by granting licenses to 11 payment banks in 2015 and 10 small finance banks, which would address niche areas in the banking system. In April 2017, RBI released a discussion paper on setting up of Wholesale and Long-Term Finance (WLTF) Banks to fund long term Infrastructure and corporate projects.
A clear focus in objectives would help these institutions in raising resources and deploying them more efficiently. This initiative could not have come at an opportune time. Due to the ongoing NPA issues, commercial banks are already wary to take further long-term exposures thus creating a critical funding gap for these projects. RBI data on industry-wise deployment of Gross Bank Credit shows that Bank Credit growth is charting a Year-on-Year (Y-o-Y) decelerating trend. In March 2017, Y-o-Y credit growth rate of Banks was 7.4% as against 9% in March 2016. According to a recent estimate, India needs over $1.5 trillion for infrastructure alone over the next ten years leave aside the funds required for long gestation projects in industrial and commercial sector.
Prof. Gourav Vallabh, Professor of Finance, XLRI, Jamshedpur and Mr. Suraj Chatrath, Management Professional and Stanford alumnus with global experience across banking, financial services and technology writes this piece for the July edition of Economy Watch.