In the Doldrums: Burgeoning stress continues to constrain banks’ lending capacity

Burgeoning stress continues to constrain banks’ lending capacity

Asset quality is one of the chief concerns of the Indian banking sector at present. The high level of stress on the banks’ books is not only impacting their profitability but is also a looming risk for a massive credit crunch, which, if unresolved, has the potential to choke GDP growth. As per the Financial Stability Report (FSR) of the Reserve Bank of India (RBI) (released in June 2017), the gross non-performing advances (GNPAs) ratio of all the scheduled commercial banks (SCBs) rose from 9.2 per cent in September 2016 to 9.6 per cent in March 2017.

About one-fifth of these stressed loans are on account of the infrastructure sector, particularly the power, road, steel and shipping segments. Sector-specific issues and heavi ly leveraged balance sheets have impacted the pace of project execution, resulting in poor cash flows for developers. The banking stability indicator worsened between September 2016 and March 2017 due to a deterioration in asset quality and profitability. The macro stress test shows that under the baseline scenario, GNPAs of SCBs may rise from 9.6 per cent in March 2017 to 10.2 per cent by March 2018. Although slippages remain elevated, they are expected to fall marginally in the current fiscal year (2017-18) on account of the recognition of stress by banks.

Sectoral woes

Sector-wise, cement, construction and infrastructure are major contributors to stressed assets on bank books. Since 2015, the stress advances ratio (proportion of stressed loans in the total credit outstanding to the sector) has been quite high for all these sectors. In cement, however, there has been a sharp rise from a sub-20 per cent level to over 34 per cent in March 2017. As of March 2017, the stressed advances ratio for the construction sector is 24.5 per cent and that for infrastructure (including transport, power, roads, aviation, etc.) is 18.3 per cent. It is pertinent to note that infrastructure accounts for about 34 per cent of the total bank credit outstanding.

Within the infrastructure space, power and telecom remained areas of concern, contributing a sizeable proportion to the non-performing assets (NPAs) emanating from the sector. According to the June 2017 FSR, the telecom sector had the largest debt with negative profitability. The bottom lines of telcos have taken a severe hit due to the rising tax burden and high spectrum acquisition costs. Further, the entry of Reliance Jio Infocomm Limited has increased the competitive intensity of the industry.

The issues plaguing the power sector like a lack of fuel supply agreements or coal linkages, the inability of state discoms to sign new power purchase agreements, an increase in the cost of imported coal, etc. continue to keep buyers for stressed assets at bay, despite banks taking substantial haircuts.

Decelerating bank credit

During the period 2012-13 to 2016-17, the year-on-year growth in bank credit to the infrastructure sector declined sharply from 18 per cent in 2012-13 to turning negative in 2016-17. As of September 2017, the exposure of banks to the sector stood at Rs 8,949 billion. The infrastructure sector witnessed a contraction in credit growth during 2016-17 primarily driven by a slowdown in investment in the power sector. This is the first time in the past five years that credit growth in the sector has slipped into a negative zone. The slowdown in credit offtake in power is on account of significant slackening in the thermal power segment.

Key buyer groups

Private equity (PE) players: Project equity has gained traction only after 2013-14. This has primarily been a result of the shift in the investment strategy of PE players, moving away from investing in early-stage projects which gave them subdued returns (due to execution delays) towards investing in operational projects offloaded by stressed developers/promoters. Entities such as IDFC Alternatives, the Macquarie Group and I Squared Capital are actively pursuing such transactions.

Sovereign wealth funds (SWFs)/Pension funds: These funds form the emerging set of buyers for asset sales in India. These investors are placing their bets on improving regulations and higher growth prospects. Active pension funds include the Canada Pension Plan Investment Board (CPPIB), Caisse de depot et placement du Quebec (CDPQ), and the Public Sector Pension Investment Board. Key SWFs are the Abu Dhabi Investment Authority (ADIA), the Government of Singapore Investment Corporation and the Kuwait Investment Authority.

Asset reconstruction companies (ARCs): Currently, there are 23 ARCs in the country and it is estimated that around ten applications for new licences are pending for approval with the Reserve Bank of India. As per CRISIL estimates, the total outstanding assets under management with ARCs is about Rs 750 billion as on March 31, 2017. Of the registered ARCs, assets of the top three players – Asset Reconstruction Company (India) Limited (Arcil), JM Financial ARC and Edelweiss ARC – account for more than two-thirds of the total assets under management with ARCs.

Targeted tie-ups: Investors are approaching stressed assets either through direct acquisitions, or through purchasing stakes in ARCs. In addition, new investment platforms and joint ventures are being formed, specifically targeted at taking exposures in stressed assets. CDPQ-Edelweiss, Piramal Enterprises-Bain Capital, and Kotak Mahindra-CPPIB are a few examples of such tie-ups.

Insolvency and Bankruptcy Code, 2016

To address the problem of stressed assets, the biggest challenge is to find a new promoter/ investor group that would willingly takes over the management of the underlying asset at a valuation that is acceptable to the offloading entity (be it a bank, a promoter under stress, or a promoter simply intending a monetisation move). There has been a lack of consensus between lenders and promoters which has delayed decision-making and resulted in the limited success of restructuring schemes. All the recent policies, such as strategic debt restructuring (SDR) and the Scheme for Sustainable Structuring of Stressed Assets (S4A), for instance, have their own areas of concern.

Until now, there were multiple laws dealing with insolvency and bankruptcy cases. Overlapping jurisdictions of laws and a lack of clarity in their provisions made the resolution process complex, time-consuming, fragmented and ex-

pensive, with low recovery rates. The Insolvency and Bankruptcy Code [IBC], 2016, was therefore introduced to ensure that decisions are taken in a time-bound manner. The code, more than any other bankruptcy law in the country,  focuses on corrective action, and instead of shutting down the project, it focuses on remedial action. The effective implementation of the code will potentially lead to the release of capital locked up in NPAs over the medium term, ARCs churning capital faster and enhancing returns, and an increase in investor confidence by making the recovery process predictable.

In a recent ordinance to checkmate unscrupulous promoters who are trying to buy back their assets at much lower valuations, the government has enacted stricter norms debarring wilful defaulters from bidding for their stressed assets.


The mounting stress level has choked off much of the lending capacity of banks to the infrastructure sector. Large quantum of bank loans have been stuck in assets and pressure from the central bank is increasing to reduce the same. This is prodding the sale of assets, which are finding takers who want to diversify their exposure or foray into the Indian markets (with regard to international players).

RBI has recently proposed the setting up of wholesale and long-term finance (WLTF) banks, especially to fund infrastructure and greenfield projects, with a minimum capital requirement of Rs 10 billion. These banks will take care of the asset-liability mismatch issues faced by regular commercial banks in providing credit to long-gestation infrastructure projects.

Though reflective of the government’s tough stance with respect to defaulters, it is too early to say that the IBC will be successful in addressing the banks’ NPA problem. A number of issues continue to hinder its progress. For instance, banks will be reluctant to take deep haircuts in sectors such as steel and power, which have fallen victim to the downturn in market conditions. However, the intent to keep a check on wilful defaulters has created fear among promoters of liquidation of their business or takeover of the company’s management.

The government’s recent announcement of recapitalising banks to the tune of Rs 2 trillion is a huge positive as it will not only help banks lend to crucial sectors of the economy such as infrastructure but also help with balance sheet clean-up. Given the quantum of capital infusion, it will address both the issues of growth capital and capital required to absorb losses arising out of elevated provisioning requirement for NPAs. Moreover, the thrust to infrastructure will create direct and indirect positive cascading effects for a number of related sectors.