RBI should lower group lending norms to 25%
The slowing economy, and the shortage of critical fuels like coal and gas, has undoubtedly worsened the non-performing asset (NPA) situation of banks, but the large levels of debt given to individual companies with little relation to their ability to repay does suggest banks have been quite lackadaisical in terms of their lending. RBI data puts the gross NPA ratio of public sector banks at the end of March 2014 at 4.7%, up 90 bps over March 2013.To be sure, RBI has initiated several measures to stem the rot, among which is a mechanism to help detect potentially bad loans early on and to ensure some action is taken within a specified period. That apart, norms for restructured assets have been tightened to disincentive banks from recasting loans and RBI has also cautioned lenders on the unhedged foreign exchange exposures of their customers.
However, much of this is like bolting the stable door after the horse has bolted and what’s needed is a much closer look at the promoter and his financial wherewithal before loans are sanctioned. As Arundhati Bhattacharya, chairman, State Bank of India (SBI) recently observed in this newspaper, what is important is the colour of the promoter’s equity and whether or not he has a Plan B in place. Also, as Bhattacharya pointed out, banks must check with other lenders to assess whether the equity being brought in for one project jeopardises the viability of another one.
In this context, it is surprising that the central bank has left the company and group exposure norms for banks untouched for so long. The current norms—banks can lend 15% of their capital funds to a single company and 40% to a group—are way too high. The argument that the rules were relatively relaxed so as not to stifle growth in a developing economy might have been valid at one point in time, but with so many business groups having emerged, a tightening of the norms is long overdue. RBI states, in its annual report, that it intends to review them, indicating that the current group exposure of 40% of the bank’s capital—and 50% if infrastructure finance is included—needs to be brought in line with global standards. That would imply a lower exposure of 25%. Given how some groups seem to be perennially stretched financially, 20% might be safer, though there will be tremendous pressure on the political system to prevent this from happening. For individual companies too, the current 25% (including infrastructure) is way too high, 10% should suffice; going by the large loan recasts, it would appear banks have resorted to evergreening accounts to prevent a default. As RBI has pointed out in its annual report, the increase in the quantum of restructured standard advances reflects the hidden stress in their portfolios; the share of such advances to gross advances rose 10 basis points to 5.9% at the end of March, 2014 over the previous year. The only way then to protect costly and scarce capital is by reining in exposures.