By Invitation: RBI reports: What went under the radar

RBI reports show that NBFCs did better and systemic risk is shifting from banks to MFs

Two reports from the RBI on banking have come out in quick succession, the half yearly Financial Stability Report (FSR) and the annual Report on trend and progress in banking 2017.

For a review of a sector whose principal problem is bad loans, they are remarkable for what they do not say, as there is little causal analysis. There is much data and we have to form our own conclusions.

There are a few other striking aspects, which are also not analysed much. One relates to the performance of NBFCs, the so-called shadow banking players and the other pertains to the distinct shift in systemic risk away from banks to mutual funds and markets.

On bad loans, the FSR holds NPAs responsible for the elevated risks to the banking sector, but the statement that ‘asset quality of banks deteriorated sharply following the AQR in July 2015’ only explains the massive jump in NPAs during 2016 and 2017 but not why our banks have one of the highest NPA ratios in the world (10.2 per cent as of March 2017).

Problems may recur

For some time now, the Ministry has referred to the ‘indiscriminate lending’ in the past, while in the RBI reports, economic distress seems to be the theme. But other factors are broadly hinted at — highly leveraged funding of PPP projects in infrastructure, poor project appraisal capabilities leading to outsourcing of appraisal to merchant bankers and creating conflict of interests, fuel linkage issues in power sector and so on.

Leaving aside infrastructure, stressed assets span a wide swathe of industries — basic metals, vehicles and transport equipment, cement, construction, textiles, engineering, mining and quarrying, food processing and construction. It is hard to envisage so many sectors affected by economic stress.

Indiscriminate lending and poor appraisal are qualitative and governance issues, especially in public sector banks. The lack of transparency in the data makes it impossible to decipher what portion of bad loans is due to wilful defaults, economic distress and poor lending practices.

One is left wondering then, that while solutions such as write-offs and insolvency may bring down numbers and recapitalisation may increase the lending capacity of banks, but with nothing concrete on qualitative or governance problems, there is no guarantee that the problem will not recur. Perhaps, the Government is hoping that mergers, when they happen, will somehow magically solve these problems.

Secondly, the NBFC sector seems to have fared better amidst the gloom and doom, despite being dependent on other institutions for resources (the deposit taking NBFCs are a small percentage).

NBFC’s impressive show

Numbering around 11,500, their credit growth at 13 per cent during FY2017 was impressive in a scenario where credit appetite was sluggish; even more impressive were their financials — higher RoA of 1.6 per cent (0.4 per cent for banks), lower NPAs at 4.9 per cent (10.2 per cent for banks) and higher CRAR of 22.8 per cent. This is noteworthy, considering their dependence on banks (40 per cent) and mutual funds (37 per cent) for resources and being subject to stricter regulations.

Their performance looks more surprising when we consider their credit exposure —60 per cent of outstanding was to industry, including large industry and infrastructure, while retail loans, their traditional business, was only 17 per cent and yet their gross NPA ratio was only 4.9 per cent. Even allowing for their asset classification norms being different (now being gradually brought on par with banks), the vast difference in bad loan levels not only needs explaining but also discounts the economic distress theory.

Finally, there are distinct shifts in systemic risks. Assets under management (AUM) of mutual funds (MFs) grew to a massive ₹20 trillion by September 2017, rising by 17 per cent from March, as compared to the growth of 8 per cent in bank deposits.

The MFs are major suppliers of funds to the system, next only to banks (receivables of MFs from the financial system were around 38 per cent of their average AUM). The interconnectedness of these institutions makes for interesting flows of funds — bank deposits migrated to mutual funds, and a large part of the same were invested back in banks and NBFCs.

The combined exposure (gross receivables) of MFs and insurance companies to the banking sector was around ₹5 trillion, accounting for over 45 per cent of their total receivables. Interestingly, about 49 per cent of mutual fund holdings are held by institutional investors (banks and corporates), which also points to the continued sluggishness in the investment climate.

While the number of dominant banks has come down and systemic losses from the default of a bank have declined, the RBI feels that continued flows to MFs without increase in depth and liquidity (evidenced by a diverse ownership of securities) or a commensurate increase in number of listed companies or supply of fresh equities could lead to crowding out, which could enhance systemic risk.

The writer is an independent consultant

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