In the past two years, recognising and resolving non-performing assets has become a central issue in the Indian banking sector, as the Reserve Bank of India pushed domestic lenders to unveil the full extent of their bad loans. Rekha Gupta Menon explores the impact this has had on the country's banks.

IDBI Bank

The Indian banking sector continues to suffer from the malaise of bad loans. Stressed assets, which include non-performing loans (NPLs) along with restructured advances, are at an all-time high.

According to a report on Indian banks by global consulting firm McKinsey, stressed assets in the banking sector have grown by about 25% annually from 2013 to cross Rs10,000bn ($155bn) mark in December 2016.

“The stressed assets load now surpass the net worth of the Indian banks – especially for state-owned ones,” says Joydeep Sengupta, senior partner at McKinsey Singapore and head of the company's Asia-Pacific banking practice. “Provisions are nowhere close to what is needed – there is nearly a Rs6000bn gap between distressed loans and provisions,” he adds.

Lending constraints

This burden of distressed loans is putting pressure on profitability and constraining banks’ ability to lend. In fiscal year 2017, the Indian banking sector’s loan growth was the lowest it had been since 2010. The McKinsey report stated that loan growth stagnated in fiscal year 2017, with bank credit books shrinking by 0.1% in the last quarter. On the back of falling corporate credit in real terms, growth in private investments started to shrink in fiscal year 2016, and further contracted by 7% in the first half of fiscal year 2017.

Painting a rather sombre picture of the Indian banking industry, rating agency S&P Global Ratings says that with weak asset quality and shrinking capital continuing to affect the country’s public sector banks, stress on the banking sector will not ease any time soon. S&P forecasts that the industry’s total stressed assets will increase to between 13% and 15% of total loans by March 2018, compared with 12.3% in the first half of fiscal year 2017.

State-backed public sector banks, which contribute nearly 70% of the Indian banking industry’s assets, account for more than 80% of the industry’s bad loans. Having traditionally shouldered the burden of nation-building objectives, these banks have a disproportionate exposure to sectors with a high share of stressed assets, such as infrastructure and metals.

In fiscal year 2017, the gross non-performing assets (NPAs) ratio – the share of gross NPAs as a percentage of total advances – at Indian public sector banks varied on average between 9% and 14%. Banks burdened with higher NPA levels, such as IDBI Bank and Indian Overseas Bank, reported gross NPA ratios exceeding 20%. Private sector banks performed on average much better than their public sector counterparts. For instance, HDFC Bank’s gross NPA ratio was 1.05%, the lowest in the industry.

RBI toughens up

Bad loans have long been a key concern among Indian banks, but the true extent of the problem came to light only after the central bank and banking industry regulator, Reserve Bank of India (RBI), initiated a first-of-its-kind formal asset quality review process in the second half of 2015. The aim was to get banks to recognise stressed assets in a timely manner, along with preventing them from under-reporting these stressed assets.

“The asset quality review has taken a massive stride forward in bringing the scale of this problem out in the open and stirring a public debate about it,” RBI deputy governor Viral Acharya said at an event in February 2017. However he noted that relatively little has been achieved in resolving the underlying assets that the banks had lent. “Several resolution mechanisms and frameworks have been offered by the RBI to banks to get this going, but the progress has been painfully slow,” he added.

Some schemes introduced for asset resolution include the strategic debt restructuring scheme, which allows banks to take control and dispose of NPAs, and the sustainable structuring of stressed assets, which allows banks to convert their unsustainable loans to equity in the borrowing company.

“Most of these schemes were too prescriptive and difficult to implement,” says Abizer Diwanji, partner and national leader at EY India. He says the most promising development is the 2016 Bankruptcy Code with the National Company Law Tribunal (NCLT) being notified as the adjudicating authority for the corporate insolvency and bankruptcy cases.

“This should ensure the time-bound resolution of stressed assets,” says Mr Diwanji. ICICI Bank filed the first insolvency case under the new bankruptcy code in December 2016 against a steel-making company with a debt of Rs9.55bn.

India Tier 1

Bankruptcy Code boost

Arundhati Bhattacharya, chairman of State Bank of India, the country’s largest bank, refers to the Bankruptcy Code and NCLT as the “missing piece” in the asset resolution process. This, along with a recent state ordinance that authorises the RBI to directly intervene with banks to ensure resolution of distressed loans, will certainly have a very positive impact on the NPA issue, she says.

Rana Kapoor, managing director and CEO of private sector lender Yes Bank, says: “With RBI’s asset quality review in fiscal year 2016 now behind us and the recent amendment to the Banking Regulation Act that accords flexibility to the RBI to expedite the resolution of NPAs, the concern on asset quality has moved from recognition to resolution. Going forward, a well-oiled insolvency and bankruptcy framework is further expected to facilitate a faster resolution process.”

On this topic, Rajiv Anand, executive director, retail banking, at private sector lender Axis Bank, says: “Over the past two years, the focus was on recognition of the non-performing loans, hence the NPA numbers went up significantly. Now the focus is on resolution. With the involvement of both the government and RBI, I am hopeful that we will move into resolution mode.” He believes that progress in asset resolution will become visible in the next 12 to 18 months.

Boosting capitalisation

Capitalisation will be another key challenge for Indian banks. Banks need capital to meet their regulatory requirements and to also make large ‘haircuts’ on loans to stressed projects that are deemed unviable. Haircuts enable banks to sacrifice a certain part of the outstanding loan amount without fear of future vigilance action.

It is estimated that under Basel III norms, Indian public sector banks would need about Rs1800bn of equity capital by 2019. The government has already injected Rs930bn between 2009 and 2016, and announced a further capital infusion of Rs750bn by 2019. Since the government has inherent limitations in providing further capital, however, public sector banks need to explore various options to meet their significant capital shortfalls.

Popular options include the sale of non-core assets and raising capital through private equity players or the open market, while for weaker banks, consolidation is a much-discussed option. Renny Thomas, who heads McKinsey India’s financial services practice, says: “Empirically, across the world, resolution of NPA [crises] involved sector consolidation and we can expect to see this in India.”

Over the past year, State Bank of India’s five associate banks have merged with the parent bank and more consolidation is expected to follow. Mr Thomas points out that consolidation should ideally happen between healthy banks, so having both capital and talent is essential. Improvement in governance and risk management practices is also important, he adds.

In terms of India’s weaker banks, the RBI is attempting to improve fiscal discipline. The regulator has placed three poorly performing public sector banks – IDBI Bank, UCO Bank and Dena Bank – under regulatory supervision, dubbed 'prompt corrective action'. This restricts lending and operational activities while the banks are nursed back to health. The three banks have high net NPAs and negative return on assets that breach the risk threshold levels set by the RBI.

In recent months, nearly 10 public sector banks, including IDBI Bank, Indian Bank, Punjab National Bank, Indian Overseas Bank, Bank of India and Union Bank of India have also completed major reshuffles among their senior management. While some were due for a change, at others such as IDBI Bank the movements came largely because of their inability to address the NPA issue.

NPA ratios

The demonetisation effect

Banking industry consultant Ashvin Parekh, managing partner at Ashvin Parekh Advisory Services, points out that apart from structural and systemic issues, a key challenge for Indian banks in fiscal year 2017 has been the disruption caused by India’s demonetisation exercise.

On November 8, 2016, the government suddenly pulled high-value Rs500 and Rs1000 currency notes out of circulation, ostensibly to get rid of black money and eliminate counterfeit currency. As these high-value notes accounted for more than 86% of the country’s predominantly cash-based economy, it led to serpentine customer queues in front of banks to deposit old notes and withdraw new ones. 

While the situation normalised mid-way through the fourth quarter of fiscal year 2017, demonetisation took away banks’ focus from loan recovery operations during the note-ban period, says Mr Parekh.

SBI’s Ms Bhattacharya agrees. “Demonetisation took away a quarter of our regular operations. Our bank staff was predominantly focused on taking deposits and exchanging notes. Regular loans and advances got impacted. That was an opportunity lost,” she says. In addition, while banks’ deposit base swelled, the high liquidity combined with slow credit off-take led to concerns of margin compression.

Digitisation boom

Nonetheless, demonetisation produced a positive effect in digitisation. Cash shortages, combined with a concerted government pitch for cashless transactions, gave a fillip to digital banking and digital payments.

Digital transaction volumes jumped significantly during demonetisation. Although the latest RBI data suggests both cash and digital transactions have almost reverted to pre-demonetisation levels, industry experts contend that digital awareness and usage have risen exponentially.

“In the normal course it would have taken us three years to achieve the current awareness levels on digital banking and payments. Also, although digital transactions have dipped after demonetisation, they have settled at a level far above pre-demonetisation levels,” says Ms Bhattacharya.

McKinsey’s Mr Sengupta says demonetisation is a major game changer. “We have seen a surge in digital payments on the back of demonetisation. More people are turning to [e]wallets, cards and mobile apps instead of cash – which has benefited some of the fintech and payments players,” he says.

Even with deposit and payments growth tapering off after the relaxation of restrictions, he adds, banks now have a larger, much more digitally engaged customer base to tap into.

Yes Bank’s Mr Kapoor believes the growing focus and awareness of digital transactions could have a transformative impact on the banking sector. “The Indian population holds about 47% of its financial assets in the form of bank deposits and 11% in the form of currency,” he says. “Now, with policy thrust on a ‘less cash economy’ gaining traction, there is likely to be a reallocation from cash holdings to bank deposits.”

India's pre-tax profits

A BANK-BY-BANK ASSESSMENT

State Bank of India

India’s largest commercial bank, SBI, has formally merged its five associate banks with itself, while taking over a niche bank that lends to women as of April 2017. This is the first large-scale consolidation in the Indian banking sector. This merged entity accounts for approximately 20% of deposits and advances in the country, has 24,017 branches, 59,263 ATMs and caters to 420 million customers.

In fiscal year 2017, SBI reported a net profit on a standalone basis of Rs104.8bn, a 5.36% increase from Rs99.5bn in fiscal year 2016. However, when including the results of the subsidiary banks, the net profit dips sharply to Rs2.4bn in fiscal year 2017, from Rs122.2bn in fiscal year 2016. The gross NPA ratio of SBI on a standalone basis was 6.9%, which rose to 9.04% for the consolidated entity.

SBI chair Ms Bhattacharya dismisses concerns that associate banks’ NPAs will impact the bank’s overall performance. “If such a large institution like SBI could be brought to this stage with strong performance parameters, there is no reason why associate bank performance cannot be improved,” she says. However, she cautions that this will take time.

SBI was long viewed as a slow-moving behemoth, but that perception has now changed. Digitisation, virtualisation, cloud, big data and office productivity solutions are some of the areas the bank is working on. Its annual IT spend is well over Rs64.84bn, growing at 25% to 30% every year. SBI is working towards being 'future ready', says Ms Bhattacharya. Between fiscal years 2015 and 2017, the number of mobile banking transactions at the bank grew from 77 million to 217.3 million, and in value terms, the transactions grew from Rs115.69bn to Rs5800bn.

Bank of Baroda

Bank of Baroda is the second largest public sector bank in India by Tier 1 capital, but is in the third position behind Punjab National Bank in terms of assets, which are worth Rs7200bn. The bank reported a pre-tax profit of Rs30.2bn in fiscal year 2017, against a loss of Rs62.33bn for the previous fiscal year. The gross NPA ratio was more than 11% in the first three quarters of fiscal year 2017. Although the ratio had gone down to 10.38% by the end of the year, it was still higher than 9.99% at the end of March 2016.

Bank of Baroda is India’s most international bank, with 59 branches in 15 countries. In the fourth quarter of fiscal year 2017, its international business contributed 27.14% to its total business. The bank has 5422 branches and 10,520 ATMs and has been focusing on increasing its digital presence. Reflecting the trend in the country of rapid growth in mobile banking, Bank of Baroda’s mobile banking transactions grew year on year by 217.03%, while net banking transactions grew 38.54% year on year.

Punjab National Bank

Punjab National Bank announced in 2016 that it was “waging a war” against bad loans, and since then its performance has improved significantly. The bank registered a pre-tax profit of Rs18.8bn and a net profit of Rs11.9bn in fiscal year 2017, against a pre-tax loss of Rs52.67bn and a net loss of Rs36.9bn in fiscal year 2016.

Fresh slippages have nearly halved over the 2017 fiscal year. The bank’s gross NPAs dropped from Rs558.18bn in fiscal year 2016 to Rs553.7bn in fiscal year 2017. Accordingly, the gross NPA ratio reduced from 12.9% at the end of March 2016 to 12.53% at the end of March 2017.

Punjab National Bank has 6937 branches and 10,681 ATMs and has increased its focus on digital banking. Internet banking transactions have doubled over the past year to 37.1 million, while mobile banking grew from 17.4 million transactions to 18.1 million.

Bank of India

Established more than 100 years ago, Bank of India is the country’s fourth largest public sector bank by assets with a balance sheet of Rs6300bn, 5123 branches and 7717 ATMs. In fiscal year 2017, Bank of India’s performance remained weak, although it improved from the previous year. It reported a pre-tax loss of Rs24.12bn, which was lower than the loss of the previous year. Standalone net losses dropped from Rs60.89bn in fiscal year 2016 to Rs15.58bn in 2017. The gross NPA ratio was high in both years: 13.22% in fiscal year 2017 and 13.09% in 2016.

Local media reports suggest that to overcome the burden of bad loans, the bank is exploring opportunities to divest stakes in some non-core subsidiaries. In 2016, the bank sold an 18% stake in Star Union Dai-ichi Life Insurance Company to its Japanese partner for Rs5.4bn. Earlier in 2017, it sold its entire 5% stake in credit information firm TransUnion Cibil Ltd to TransUnion International Inc for Rs1.9bn. 

Union Bank of India

Union Bank of India is the country’s sixth largest public sector bank by assets with a balance sheet of Rs4500bn. It has 4282 branches and 7518 ATMs nationwide. NPAs hit the bank’s performance in fiscal year 2017, with it experiencing a sharp 80.15% drop in yearly pre-tax profits to Rs3.4bn. The bank’s net profit also dipped from Rs13.52bn in fiscal year 2016 to Rs5.55bn in fiscal year 2017. In the same time period, gross NPAs increased from Rs241.71bn to Rs337.12bn and the gross NPA ratio rose from 8.7% to 11.17%.

The bank is working on an intensive transformation exercise, which involves centralising key business processes such as claims processing, encouraging digital banking adoption, and streamlining human resources and the operational infrastructure at the bank. Union Bank of India’s internet and mobile banking and digital transaction volumes are steadily increasing. At the end of March 2017, the bank had 1.13 million registered mobile banking users and 1.53 million internet banking users.

IDBI Bank

IDBI Bank has been struggling with an ever-increasing bad loans problem over the past two years. In fiscal year 2017, IDBI Bank’s gross NPAs jumped 80% to Rs447.5bn, and profitability was severely impacted as well. The pre-tax losses for fiscal year 2017 increased by 77% to Rs84.3bn and the gross NPA ratio increased quarter on quarter to above 20% by the end of March 2017, compared with 10.38% a year earlier.

As a result, rating agencies have downgraded the bank, citing weak asset quality and questionable recovery prospects. S&P Global Ratings expects IDBI Bank’s asset quality to remain weak over the next 12 months due to the bank’s sizeable exposures to vulnerable corporate and infrastructure segments.

The RBI has put IDBI Bank under “prompt corrective action”, or regulatory supervision, to help improve its fiscal health. In a recent interview with a business news channel, Indian finance minister Arun Jaitley said the bank’s poor financial health was a key barrier to the privatisation plans announced by IDBI Bank and was also a key driver of the bank’s leadership change in March 2017.

IDBI Bank recently announced it has crafted a comprehensive turnaround strategy, with a focus on augmenting the capital base and recovery from NPAs. New managing director and CEO Mahesh Kumar Jain says: “We are looking at all avenues to improve our capital position and bring the bank on the recovery track. We will look at aggressive recovery and cost cutting measures and plan on churning our corporate book and risk-weighted assets, which should also ease the pressure on capital. The government of India, our principal shareholder, continues to support the bank.”

ICICI Bank

India’s largest private sector bank and the second largest banking entity by assets, ICICI Bank has a balance sheet of Rs9860bn, 4850 branches and 13,882 ATMs across the country. Among private sector lenders, ICICI Bank has been hit hardest by the bad loan crisis. Bad loans jumped to Rs425.51bn at the end of the fourth quarter of fiscal year 2017, a 59.2% increase from the previous year. Gross NPAs as a percentage of total customer loans stood at 8.74% at the end of March 2017, compared with 7.9% in the previous quarter and 5.82% a year before.

Going forward, the bank said it expects NPA additions for fiscal year 2018 to be significantly lower than the previous year. ICICI Bank also expects some NPAs to be resolved and upgraded.

ICICI Bank’s standalone net profit increased marginally between fiscal years 2016 and 2017 to Rs98.01bn, or Rs113.4bn on a consolidated basis. In fiscal year 2017, the bank’s total loans grew to Rs4600bn, a growth of 6.7% year on year, which is being driven by the retail sector. Retail loans grew by 18.5% year on year and their share of total loans increased from 46.6% at the end of March 2016 to 51.8% at the end of March 2017.

On the digital front, channels such as internet and mobile banking, point of sale and the bank’s call centre accounted for more than three-quarters of savings account transactions in fiscal year 2017. The number of mobile banking transactions doubled in fiscal year 2017 compared with 2016, while the value of mobile banking transactions increased by 168% in the same period.

HDFC Bank

In The Banker’s 2016 Top 1000 ranking, HDFC Bank inched forward to become the third largest Indian bank by both assets and Tier 1 capital. In the 2017 ranking, the bank has not only retained its spot but it is steadily closing the gap with the bank immediately above it, ICICI Bank.

In fiscal year 2017, HDFC Bank’s balance sheet grew by 25% to Rs8900bn, versus a 9.79% growth at ICICI Bank. Additionally, because of its retail-focused business model and relatively smaller exposure to project finance, HDFC Bank has far fewer bad loans than ICICI Bank, which is reflected in its healthy balance sheet.

In the past two years, HDFC Bank has reported the highest pre-tax profits among Indian banks. Its pre-tax profit for fiscal year 2017 was Rs233.65bn, a 22.51% growth over 2016. HDFC Bank’s gross NPAs increased by 35.4% between fiscal years 2016 and 2017, from Rs46.95bn to Rs63.57bn. However, in this period, gross NPAs as a percentage of total advances marginally increased from 0.94% to 1.08%, which is among the lowest in the industry.

HDFC Bank has 4715 branches and 12,260 ATMs. The bank has cut its headcount in the past two quarters, and total number of employees was 84,325 at the end of March 2017, against 95,002 at the end of September 2016 and 87,555 at the end of March 2016. The bank attributes this employee reduction to digitisation, which is leading to increasing straight-through processing volumes, to lower turnaround times and better customer experience.

Axis Bank

Axis Bank is the third largest private sector bank in India in terms of assets and Tier 1 capital. The bank has been struggling with bad loans in recent years and the financial results reflect this. Standalone net profits for fiscal year 2017 dropped by 55.25%, from Rs82.2bn in fiscal year 2016 to Rs36.79bn. On consolidated terms, net profits dropped by 52.01%, from Rs126.9bn to Rs59.5bn in the same time period. Axis Bank’s gross NPAs grew by nearly 250% to Rs212.8m in fiscal year 2017, while the gross NPA ratio shot up from 1.67% at the end of fiscal year 2016 to 5.42% at the end of fiscal year 2017.

Announcing the results, Shikha Sharma, managing director and CEO of Axis Bank, said that based on this performance, the bank feels the worst of this credit cycle is largely over. However, she added: “We recognise multiple uncertainties that still remain with regard to resolution mechanisms for stressed loans. We also recognised that [the fourth quarter of 2017] is a seasonally strong quarter on recoveries and the strength in this quarter might not be directly imputable to the next full year.”

Axis Bank has 3304 branches across India and a very strong focus on digital channels. It took the bank 18 months to acquire its first 1 million mobile banking customers after launching its mobile banking service in fiscal year 2014, but only four months to sign up its last million, according to head of retail banking Rajiv Anand.

Axis Bank has almost reached 5 million mobile banking customers. Nearly 66% of its banking transactions are done through digital channels, 21% are completed through ATMs and 13% through branches. However, the bank plans to continue opening as many branches as it did in 2016, says Mr Anand.

“There is a direct correlation between [the] number of physical bank branches and the bank’s market share. We do not categorise customers as digital or branch customers. Every customer is unique and our aim is to give them a broader omnichannel experience,” he says.

Kotak Mahindra Bank

Kotak Mahindra Bank ranks fourth by assets (worth Rs2760bn) among India’s private sector banks, and has 1369 branches and 2163 ATMs. The bank completed its integration process with ING Vysya Bank in fiscal year 2017 – a merger that came into effect in April 2015.

The bank reported a 46% growth in pre-tax profits from Rs50.23bn in fiscal year 2016 to Rs73.32bn in 2017. The consolidated annual net profit increased by 42.24% in fiscal year 2017 to Rs49.4bn.

The bank’s gross NPAs grew 26.09% year on year, reaching Rs38.04bn in fiscal year 2017. However, gross NPAs as a percentage of total advances remained at a relatively low 2.2% in fiscal year 2017, versus 2.06% the previous year.

Kotak Mahindra is heavily investing in digital solutions and is focusing on online customer acquisition, digital payments and analytics. In March 2017, it launched a zero-charge digital bank account with instant account opening facilities. In 2017, mobile transactions at the bank grew 138% by volume and 143% by value.

Yes Bank

Private sector lender Yes Bank registered a sharp 77.64% growth in Tier 1 capital and a 33.12% increase in assets in fiscal year 2017. The bank has a balance sheet worth Rs2150bn, 1000 branches, 1785 ATMs and 20,125 employees.

In fiscal year 2017, Yes Bank’s pre-tax profit grew by 37.01% while standalone net profit grew 31.1% to Rs33.3bn, compared with Rs25.4bn in fiscal year 2016. Gross NPAs shot up 169% year on year to Rs20.18bn in fiscal year 2017. As a percentage of total advances, gross NPAs increased from 0.76% in fiscal year 2016, but still remained at a low 1.52% in fiscal year 2017.

Mr Kapoor, CEO and managing director at Yes Bank, says the bank has a well-established corporate banking and small and medium-sized enterprise franchise, and is now focusing on developing the retail banking segment. He adds that the bank is also focusing on harnessing the power of digital banking and technologies, which can generate cost reductions through enhanced process and service efficiencies.

The bank recently raised $750m of capital via a successful qualified institutional placement. This will help fuel its growth plans, according to Mr Kapoor. “Given the foregoing, we remain confident of growing at 27% to 30% compound annual growth rate over the next three years and of increasing our market share in the Indian banking industry to 3% from the current share of approximately 1.7%,” he says. 

PLEASE ENTER YOUR DETAILS TO WATCH THIS VIDEO

All fields are mandatory

The Banker is a service from the Financial Times. The Financial Times Ltd takes your privacy seriously.

Choose how you want us to contact you.

Invites and Offers from The Banker

Receive exclusive personalised event invitations, carefully curated offers and promotions from The Banker



For more information about how we use your data, please refer to our privacy and cookie policies.

Terms and conditions

Join our community

The Banker on Twitter