Early warning system

Mar 01 2014, 23:25 IST
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SummaryRBI’s proposed framework can be a game-changer for banks.

Recently, the United Bank of India (UBI) reported a large loss in the third quarter of fiscal 2014, an outcome of a five-fold increase in provisioning for delinquent loans. UBI’s financial woes were only the most acute representation of the deep risk of non-performing assets (NPAs) that pervades the banking system.

Reacting to the growing NPA challenge that it has observed, RBI, on January 30, published its guidelines towards “Early Recognition of Stressed Assets” to help bring under control the NPAs within the Indian banking system. This report came in the shadow of RBI’s own Financial Stability Report, which projected gross NPAs of the banking system to reach 4.6% by September 2014. That matters had reached such a pass, required, as per RBI, a deeper recognition that it was not sufficient to manage credit through lag indicators, such as gross NPA levels, but that there was a need to identify stress well before it results in delinquencies. This circular gives regulatory sanction (by means of incentives and penalties) to the need for continuous monitoring of accounts to ensure that borrowers attempt in good faith to achieve projections that they would have given bankers at the time they borrowed.

To understand why this paper is being released now, one would need to delve into the background of how the problem was created in the first place. As pointed out by yet another illuminating working paper of RBI on “Re-emerging Stress in Banks” published earlier in February 2014, periods of high credit growth are generally followed by periods of significant delinquencies. Growth above a certain rate might be possible for an individual bank is unlikely to be safe of the system as a whole. Based on the same paper, one could conclude that a system-wide growth in lending rates of more than 24% per annum for a sustained period increases the likelihood that loans move into the danger zone. Growth in lending rates exceeding 30% per year, a phenomenon that was seen at a certain period in the past decade, make it likely that delinquencies will be high.

The period of low interest rates immediately after the financial crisis coincided with an unreasonable rush to grow balance sheets. Debt, which was close to R1 trillion across a sample of large business houses, rose to R7 trillion over the past six years. As per reports by Credit Suisse, across large parts of the organised sector, debt

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