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In the previous article, we discussed the Government Debt Crisis threat. Today, we shall delve further in the Bad Loan arena.

On an average 75.53% of the net worth of Indian public sector banks is made up of bad loan. This is a matter of growing concern for the government and the Reserve Bank of India (RBI). Private sector banks are performing way better as compared to the state-owned banks. Yes Bank, Kotak Mahindra Bank, IndusInd Bank and HDFC Bank have reported growth in their respective net profits as opposed to public sector banks which have reported a decline in their net profits.

NPA Sectors

 

Public sector banks are inefficient; they lack the expertise in credit appraisal. A significant portion of banks’ NPAs is a result of loans obtained by fraudulent methods. This raises questions about the governance practices of public sector banks. They end up lending to wrong sectors, increasing their non-performing assets (NPA) and having negative returns on their assets. In contrast, private banks refrain from lending to certain risky sectors like infrastructure. Public sector banks, under the influence of the government, lent to many infrastructure projects.

India was almost insulated from the 2008 financial crisis, the RBI cut its policy rates and ended up flooding public banks with excessive liquidity which therefore gave loans indiscriminately.

The mounting bad debts have not only affected the profitability of public banks but also impaired their ability to grow their loan book. This has led to an overall slowdown of credit growth in the country as public banks constitute two-third of the entire credit disbursed by commercial banks.

To counter this bad loan problem RBI has initiated a Prompt Corrective Action (PCA) against IDBI Bank and UCO and is now looking into other banks with a high volume of bad loans. The guidelines under PCA are applicable to all banks operating in India without any exception. It gives the RBI the power to take strong actions in case of faltering.

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Measures that RBI can take under the PCA framework for Bad loans –

• Make restrictions on dividend payments, branch expansions, management compensation and director’s fees.
• Monitor the fresh loans granted by the banks.
• Instruct the banks to prepare a time-bound plan and commitment for reduction of NPA’s. This includes a reduction in credit expansion for unrated or low rated borrowers.
• If banks fail to show any improvement the RBI has the power to restructure them, amalgamate them with stronger ones or wind them up.

Conclusion

Close monitoring of banks’ activities by the RBI has become highly essential. Also, these actions will help in the improvement of internal controls and activities of banks. It’s imperative for all banks to comply with the guidelines and regulations set by the RBI. Further increase in bad loans will have serious repercussions on the macroeconomic stability of India. Thus, the RBI should tighten its control over the banks and banks should cooperate with them.

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