Lending Constraints: Bank credit stymied by stressed assets

Bank credit stymied by stressed assets

Banks, the predominant providers of infrastructure finance, are reeling under unprecedented stress levels leading to reduced credit availability to the sector. Currently, the banking sector’s exposure to infrastructure stands at 15 per cent of gross bank credit. After lending heavily to the sector till 2009, bank credit was impactd by the economic slowdown, poor project execution and sectoral issues caused a number of loans to become unrecoverable or stressed. This resulted in limited headroom for extending fresh loans for infrastructure projects.

Size and growth

During the period 2011-12 to 2015-16, the year-on-year growth in bank credit to the infrastructure sector declined sharply from 17.56 per cent in 2011-12 to just 4.35 per cent in 2015-16. As of September 2016, the exposure of banks to the sector stood at Rs 9,040 billion. Sectoral analysis shows that the power sector accounts for more than half the total credit outstanding in the infrastructure sector. Aviation, roads and telecom are other sectors which account for a significant share of stressed assets.

The infrastructure sector witnessed a contraction in credit growth in the first half of 2016-17, driven primarily by a slowdown in investment in the power sector. For the first time in the past five years, credit growth for the infrastructure sector in general, and the power sector in particular, slipped into a negative zone. The slowdown in credit offtake in power is on account of significant slackening in the thermal power segment.

Only the road sector witnessed some action on the ground. The first half of 2016-17 saw an uptick in credit offtake by the sector, while at the same time, lending to power generation and distribution companies reduced. Lending activity to the road sector surged on account of the revival of stalled projects and the award of new projects over the past few months.

Cost of borrowing

In order to ease liquidity conditions in the banking system and push economic growth, the Reserve Bank of India (RBI) slashed the repo rate by a cumulative 175 basis points (bps) since January 2015. However, the cut in the weighted average lending rate (WALR) by all scheduled commercial banks (SCBs) between December 2014 and June 2016 has been slightly less than 100 bps. Banks have not fully transmitted the policy rate cuts to the end-borrowers. According to the central bank, the rate cut transmitted was less than one-fifth in some cases; the problem was especially pronounced in public sector banks. As of September 2016, the base lending rate for banks was in the range of 9.3-9.65 per cent, in contrast to the 9.71 per cent rate that prevailed in September 2015.

In terms of infrastructure projects, however, fresh loan activity was muted as banks slowed credit flow to the sector which accounts for a significant portion of the banks’ stressed loans. This is also reflected in the fact that only a handful of financial closures were achieved in 2015-16.

In a bid to speed up the changes in policy rates being reflected in the banks’ lending rates, RBI introduced the marginal cost of funds-based lending rate (MCLR), effective from April 1, 2016. The new regime requires banks to set rates based on their marginal cost of funds rather than the average cost of funds, on the assumption that the former is more sensitive to changes in policy rates than the latter. The eventual pricing of fresh loans will depend on the creditworthiness of the borrower, past credit record, project viability and expected cash flows.

While the shorter-maturity MCLR has declined due to continued reductions in policy rates, there has been an increase in the term premiums (the spread added to the MCLR to determine the actual lending rate for borrowers) for term loans of one year and above. This is done so as to provide a cover to banks against riskier loans and rising non-performing assets (NPAs). The consequent rise in the spread is reflected in a near-unchanged WALR for various segments including infrastructure, which require medium- to long-term loans.

The shift to the MCLR for determining base rates is expected to aid the passing on of lower rates by banks to borrowers. So far, for public sector lenders, the rate of deposit growth has remained subdued vis-à-vis private sector banks. Also, public banks are laden with bad debt, mostly from the infrastructure sector. These factors have prevented banks from reducing lending rates in tandem with policy rate cuts.

As a result of the demonetisation of high currency notes, banks are slashing deposit rates. Lending rates are expected to follow suit, albeit with a lag, possibly giving sluggish credit expansion a much-needed boost and shoring up growth.

Stressed assets

As of March 2016, the gross NPAs of the infrastructure sector stood at about 8 per cent of the total advances to the sector, and the total stressed assets including restructured standard assets of the sector were approximately 17 per cent of the total banking system’s exposure to the sector. Indian banks, particularly those in the public sector, have been struggling with bad debts, rising provisioning for bad loans and weaker earnings. Non-recovery of loans from the infrastructure sector has impinged upon the completion of ongoing projects and fresh investments in greenfield projects. The reasons cited for the piling up of bad loans in infrastructure are the prolonged

economic slowdown, regulatory delays in clearances, persistent policy paralysis, and deficiencies in credit appraisal by banks. All these have hampered the smooth implementation of large infrastructure projects, affecting the financial health of companies.

Despite significant headwinds, notable systematic efforts have been made, especially under the new government and with support from regulators and bankers, to revitalise stalled projects and boost fresh investments to infrastructure projects. These include changes in guidelines of the strategic debt restructuring scheme, revamping the 5/25 Refinancing Scheme, the introduction of the Scheme for Sustainable Structuring of Stressed Assets, and passing the Insolvency and Bankruptcy Bill, 2015. These reforms are poised to create an effective NPA management regime which is critical to de-stress banks’ books.

The way forward

While stalled projects are reducing the ability of infrastructure companies to take credit, banks are also being cautious in extending credit to them. Th   e policy reforms introduced in the debt restructuring space need to be bolstered with a number of measures aimed at weeding out weak assets. Asset reconstruction companies can play an enabling role in the effective management of NPAs and, hence, there is a need to strengthen them. There should be greater emphasis on developing in-house capabilities for credit appraisal so as to be able to raise a red flag if there are early signs of delinquency on the part of borrowers. Addressing sector-specific issues is also essential to provide relief to projects impacted due to changes in the regulatory framework. Going forward, there is a need to further develop alternative sources of long-term financing, such as bonds and institutional equity support from the private sector.