Thursday, October 06, 2011

Why Non Performing Assets in Banks

As usual, bankers have raised the issue of interest rate hike before RBI Governor and requested for a pause or stop on interest rate which have been hiked many times during last 15 months. Bankers have pleaded that high interest rate will adversely affect loan growth and also increase the amount of bad loan. I have been advocating for last three four years that uniform rate of interest for deposits and advances should be decided by RBI keeping in view national and international situation and the same should be followed by all banks so that banks do not compete each other on the issue of interest rate and customers do not get the opportunity to adopt frequent change of bank for availing cheap loan and in turn adversely affecting the quality and quantity of loan portfolio of banks.

But I do not agree that hike in interest rate may affect overall loan growth. Loan portfolio of one bank may grow at the cost of that of others. Good customers seldom care for interest rate whereas bad customers may cheat the bank even if the rate is too low. Interest cost in any company's balance sheet constitutes negligible portion in their overall burden of expenses. As such a lit bit rise from present level may not have that much affect as non rise of interest may affect the inflation pain on entire economy .

Of course it is desirable that interest rate is kept as minimum as possible as possible and hence I always plead that RBI should fix uniform interest rate for different sectors and for different time period for overall sound health of national economy. Unnecessary and unwarranted rate war among bankers cause loss to one bank or the other and it is ultimately the government and the people of India who have to suffer.

Further I do not accept the logic of bankers that rate hike may jeopardize their loan portfolio and as a consequence of interest rate hike instances of bad assets will increase. It is bitter truth that bad assets which have been surfacing now are not creation of interest hike but the creation of the period when low interest rate regime was prevalent. Bad assets have been concealed by clever bankers and it has been in practice for last several years and now when banks are forced by RBI to ascertain amount of Non Performing Assets or bad assets strictly as per system they are constrained to declare their entire accumulated NPA latest by 31st March 2010.

It is beyond doubt to me that all newly surfaced NPA are creation of period when low interest rates were charged to customers. In my view, amount of bad assets has been growing consistently in government banks largely and mainly due to prevalent corrupt practices, due to ill motivated decision on lending taken by corrupt executives of the banks and due to inaction of corrupt officials.
Here it is worthwhile to mention that Micro Finance Institutes in various states are lending at rate ranging from 25 % to 40% to small traders, weak farmers, street vendors, and other socially backward class for various purposes. It is government banks who extend bulk money to these MFIs at low rate of interest for onward lending at higher rate of interest. These bankers without any hesitation justify lending by these MFIs at high interest rate and at the same time advocate for low rate regime .They do not foresee rise in bad debts when MFI resort to lending at high rate but fear their loan going bad if RBI do not pause hike in rate.

It is to add here that instances of loan going bad in PSU banks is much higher even when they lend to farmers at lowest rate compared to MFIs who lend to same farmers at higher rate. Similarly bankers charges rate from 20 to 30% on credit card users but the default in credit card based lending is far less than lending made to traders and manufacturers at comparative low rates.
Of course it is also true that banks are unable to recover the money from willful defaulters due to legal constraints and due to ineffectiveness of administration, police officials and the judiciary. But I have no doubt that rise in bad assets is primarily due to bribe based lending and not due to rise in interest rate or due to global recession or due to based weather as pleaded by bankers from time to time .

Since causes of the disease of poor growth of loan portfolio or that of rise in bad assets are wrongly identified, the diagnosis given to deal with pain caused by above reasons normally prove ineffective. This is why government as also banks in general have been talking of NPA for last two three decades but they have completely failed to prevent assets going bad and failed to recover the money from willful defaulters.

Politicians in general do not like that their voters be pressed hard for repayment of loan. They prefer waiver of loan or compromise to forced recovery to motivate voters in their fold. But the bitter truth is that money once given to borrower cannot come back as long as there is no fear of law or severe action.

I therefore plead that instead of focusing on interest rate government should ensure effectiveness of legal machinery and try to punish corrupt executives as soon as possible to send the message among willful defaulters that government will leave no stone unturned to recover the money from defaulters whosoever he or she may be.

Government must be liberal in lending but must not be liberal and casual in punishing those borrowers who do not repay the loan on demand and also bank officers who sanction loans after taking bribe.
Government should first identify top executives who by phone or by giving verbal instruction build pressure on subordinate officers for sanction of credit to unscrupulous borrowers and these corrupt officers left unnoticed and unpunished when such loan become bad.

Government should try to formulate such transparent policy related to Human Resource Development which do not give rise to flattery and bribery, which gives proper respect and recognition to good and honest workers. For this purpose the good culture has to be inculcated first among top ranked officers, ministers and politicians.

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