Tackling the NPA menace: Raghuram Rajan hints at significant loan write-offs by banks

Reserve Bank Governor Raghuram Rajan has indicated that “existing loans will have to be written down significantly” by banks in order to tackle the rising menace of non-performing assets.

Rajan, who made some plain speaking about the banking sector, also said “some banks will have to merge to optimise their use of resources” and advised the government to allow the boards more freedom to differentiate their (public sector) banks and offer more compensation for bank directors.

“If loans are written down, the promoter brings in more equity, and other stakeholders like the tariff authorities or the local government chip in, the project may have a strong chance of revival, and the promoter will be incentivised to try his utmost to put it back on track. But to do all this deep surgery, the bank has to classify the asset as a non performing asset (NPA), a label banks are eager to avoid,” Rajan said. Alternatively, instead of deep surgery, the banks could apply band aids, they could “extend and pretend”, lending the promoter the money he needs to make loan payments. “The project’s debt obligations grow, the promoter loses further interest, and the project goes into further losses,” he said while delivering the CD Deshmukh lecture in New Delhi.

Public sector banks are sitting on over Rs 7,00,000 crore stressed assets (including NPAs and restructured loans). The RBI has already asked banks to review certain loan accounts and their classification over the two quarters ending December 31, 2015 and March 31, 2016. The RBI has a list of accounts which banks will have to recognise as NPAs on the books even though on payments, they are not 90 days behind on the due dates.

As bank health recovers, the issue of PSU banks mergers can be addressed, he said. “Almost surely, some banks will have to merge to optimise their use of resources. But talking of bank mergers, which take a lot of management attention, especially when each bank management is preoccupied with dealing with stressed assets, is probably premature,” Rajan said. He said more decisions need to be decentralised from the government to the PSB boards, once they have been fully professionalised. “If we want to address the concern that many public banks have identical strategies and are competing for the same pie, we have to allow the boards more freedom to differentiate their banks,” Rajan said. On compensation for board members, Rajan said: “We have to pay board members of PSBs a market compensation if we are to attract decent talent.”

While the profitability of some banks may be impaired in the short run, the system, once cleaned, will be able to support economic growth in a sustainable and profitable way, he said.