{"id":117854,"date":"2021-07-08T03:38:47","date_gmt":"2021-07-08T03:38:47","guid":{"rendered":"https:\/\/fin2me.com\/?p=117854"},"modified":"2021-07-08T03:38:47","modified_gmt":"2021-07-08T03:38:47","slug":"dont-be-afraid-of-bank-npas","status":"publish","type":"post","link":"https:\/\/fin2me.com\/business\/dont-be-afraid-of-bank-npas\/","title":{"rendered":"Don’t be AFRAID of Bank NPAs!"},"content":{"rendered":"

Business failures rise when growth declines.
When Indian growth slowed in the last decade, defaults increased.
This is the normal working of the market economy, points out Ajay Shah.<\/strong><\/p>\n

<\/p>\n

An ‘NPA scare’ is afoot in India: An exaggerated fear of non-performing assets (NPAs) and about the losses experienced by lenders.<\/p>\n

Business failure, and credit losses, are integral to lending.<\/p>\n

If we shy away from all NPAs, or demonise default, this will harm economic growth.<\/p>\n

The focus on human interest stories, and on transactions that go wrong, tends to obscure the vast scale of successful lending that takes place.<\/p>\n

We need to relax a little about NPAs, and worry about the three things that are wrong with the Indian credit market: A. Banking regulation’ B. The lack of a capable bond market; and C. Bankruptcy reform.<\/p>\n

Do you want to lend with no possibility of default? This can be done: You must buy US or German 90-day government bonds, which are AAA-rated. These yield roughly 0 per cent.<\/p>\n

If you buy an Indian government bond, you are displaying some risk appetite; this is rated Baa3 by Moody’s. But then, you think that the higher risk is justified by the higher interest rate.<\/p>\n

The ghost of default hovers over most lending. The only way to achieve zero defaults is to lend to the German or the US governments.<\/p>\n

The important question is: After suffering losses on a certain part of the portfolio, does the overall rate of return work out okay? As an example, suppose there are 10 per cent NPAs, which induce a loss of 50 per cent, and on the remaining 90 per cent there is a return of 20 per cent.<\/p>\n

The overall portfolio return works out to 13 per cent: In this case, a 10 per cent NPA rate worked out fine. To say that ’10 per cent NPA is bad’, in isolation, rarely makes sense.<\/p>\n

If policy makers or board members demand extremely low NPA rates, this hampers rational financial strategies and hampers credit access.<\/p>\n

It is a bit like selling life insurance and demanding that customers don’t die.<\/p>\n

Business failure is a part of life, so credit defaults will always happen.<\/p>\n

At present, financial regulators and agencies are zealously guarding against future default and going after past defaulters.<\/p>\n

Business folk are responding to the NPA scare by pulling back from borrowing.<\/p>\n

They are using more equity capital, and hence investing less, which is harming GDP growth.<\/p>\n

Deaths faced by life insurance companies surge in a pandemic.<\/p>\n

In a similar fashion, business failures rise when growth declines.<\/p>\n

When Indian growth slowed in the last decade, defaults increased. This is the normal working of the market economy.<\/p>\n

The modern media creates a spectacle out of human interest stories.<\/p>\n

Each plane crash receives vast coverage, while thousands of humdrum flights go by unnoticed.<\/p>\n

In a similar fashion, a huge volume of debt transactions goes through successfully all the time.<\/p>\n

As financial economist Harsh Vardhan recently pointed out, about Rs 12 trillion of new credit takes place every year.<\/p>\n

But in the modern media, there is a spotlight on a few big defaults, which fuels the NPA scare.<\/p>\n

A large number of small defaults, which add up to Rs 1,000 crore (Rs 10 billion<\/em>), does not get the same spotlight as a Rs 1,000 crore default by a company led by a colourful personality.<\/p>\n

Excoriating the rich has become fashionable in these egalitarian times.<\/p>\n

This is not to say that all is well in the Indian credit market. There are three important problems that require solving: Banking regulation, bond market, and bankruptcy process.<\/p>\n

The first is the weaknesses of banking regulation. All too often, banks in India have given loans, suffered from default, and found themselves bankrupt after these defaults were paid for.<\/p>\n

But bank fragility should not fuel the NPA Scare; it should kick off improvements in banking regulation that solve this problem.<\/p>\n

The job of banking regulation is to force market-based accounting upon lenders.<\/p>\n

In the past, this has not been done. Banks have systematically overvalued their portfolios, and regulators have supported this.<\/p>\n

Regulators must force banks to assess the market value of loans and mark their portfolios to market every quarter, thus showing losses on the P&L every quarter reflecting the net credit deterioration (if any) of their overall portfolio.<\/p>\n

Regulators must test the veracity of the valuation claims of banks by requiring an auction every year of a small random sample of assets, through which the market value obtained through the sale can be compared against the claims of the management.<\/p>\n

The second problem is the bond market. Banks have short-dated deposits and are structurally unable to do long-term lending.<\/p>\n

Most infrastructure projects in India are highly risky and require commensurately low leverage.<\/p>\n

The right path to long-dated corporate debt lies in the bond market.<\/p>\n

There are, however, structural failures in financial regulation which have held back the emergence of the bond market.<\/p>\n

The losses in long-dated infrastructure and corporate lending should not fuel the NPA Scare; they should kick off the requisite bond market reforms.<\/p>\n

This is a work programme which was begun in the 2015 Finance Bill but withdrawn.<\/p>\n

The third problem is the bankruptcy code. This is about reducing the losses suffered by lenders when default takes place.<\/p>\n

The defining aphorism of this field is ‘a defaulted company is a melting ice cube<\/em>‘.<\/p>\n

As quickly as possible, the bankruptcy process needs to kick in, shift control to the committee of creditors, and find a value-maximising deal for lenders.<\/p>\n

As part of this, the bankruptcy code should force the discovery of theft by promoters, which would lead to commensurate actions against them.<\/p>\n

Regulators and agencies need to instill less fear in lenders, so that lenders are able to actively restructure debts when faced with incipient signs of distress.<\/p>\n

A small loss in restructuring is generally better than a large loss in bankruptcy.<\/p>\n

The Indian bankruptcy reform has been in play since 2016, but the elements described here have not fallen into place through the combination of regulators, courts, departments, and agencies.<\/p>\n

The problems of the bankruptcy process should not fuel the NPA scare; they should generate the energy to come back into the bankruptcy reform with fresh energy and intellectual capacity.<\/p>\n

Feature Presentation: Rajesh Alva\/Rediff.com<\/em><\/strong><\/p>\n

Source: Read Full Article<\/a><\/p>\n","protected":false},"excerpt":{"rendered":"

Business failures rise when growth declines.When Indian growth slowed in the last decade, defaults increased.This is the normal working of the market economy, points out […]<\/p>\n","protected":false},"author":3,"featured_media":117853,"comment_status":"closed","ping_status":"closed","sticky":false,"template":"","format":"standard","meta":{"footnotes":""},"categories":[6],"tags":[],"yoast_head":"\nDon't be AFRAID of Bank NPAs! - Fin2me<\/title>\n<meta name=\"robots\" content=\"index, follow, max-snippet:-1, max-image-preview:large, max-video-preview:-1\" \/>\n<link rel=\"canonical\" href=\"https:\/\/fin2me.com\/business\/dont-be-afraid-of-bank-npas\/\" \/>\n<meta property=\"og:locale\" content=\"en_US\" \/>\n<meta property=\"og:type\" content=\"article\" \/>\n<meta property=\"og:title\" content=\"Don't be AFRAID of Bank NPAs! - Fin2me\" \/>\n<meta property=\"og:description\" content=\"Business failures rise when growth declines.When Indian growth slowed in the last decade, defaults increased.This is the normal working of the market economy, points out [...]\" \/>\n<meta property=\"og:url\" content=\"https:\/\/fin2me.com\/business\/dont-be-afraid-of-bank-npas\/\" \/>\n<meta property=\"og:site_name\" content=\"Fin2me\" \/>\n<meta property=\"article:published_time\" content=\"2021-07-08T03:38:47+00:00\" \/>\n<meta name=\"author\" content=\"Mark\" \/>\n<meta name=\"twitter:card\" content=\"summary_large_image\" \/>\n<meta name=\"twitter:image\" content=\"https:\/\/fin2me.com\/wp-content\/uploads\/2021\/07\/Dont-be-AFRAID-of-Bank-NPAs.jpg\" \/>\n<meta name=\"twitter:label1\" content=\"Written by\" \/>\n\t<meta name=\"twitter:data1\" content=\"Mark\" \/>\n\t<meta name=\"twitter:label2\" content=\"Est. reading time\" \/>\n\t<meta name=\"twitter:data2\" content=\"5 minutes\" \/>\n<script type=\"application\/ld+json\" class=\"yoast-schema-graph\">{\"@context\":\"https:\/\/schema.org\",\"@graph\":[{\"@type\":\"WebPage\",\"@id\":\"https:\/\/fin2me.com\/business\/dont-be-afraid-of-bank-npas\/\",\"url\":\"https:\/\/fin2me.com\/business\/dont-be-afraid-of-bank-npas\/\",\"name\":\"Don't be AFRAID of Bank NPAs! 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