Skeletons in closet – Part I Indian Public Sector Banks. Non-Performing Assets By Dr. Bobby Srinivasan and Dr. Sudhakar Balachandran

April 12, 2016 | Posted by bobbysrinivasan << back to blog

The Indian Public Sector Bank shares recently took a big beating in value as more and more revelations took place about their non-performing assets and restructured loans. It is disheartening to learn that these banks have lent sizeable amounts of money (in trillions) to both public and private sector institutions and individual clients and many of them are reneging or defaulting on their debt. A loan against an asset is categorized as non-performing assets if both interest and part of the loan are not repaid for a continuous period of nine months.

This is a conversation between a student and his professor on this topic.

Student: Prof. with economic growth of 7 to 8% per annum and reasonably controlled inflation. I expected the share prices of PSU banks to perform well; instead they have failed to deliver miserably. I wrongly calculated that these banks will have a big spread between their deposit and the loan portfolio interest rates. They pay their customer an interest on their savings account and on fixed deposit at much lower rate not compensating for the inflation.

So, I expected their profit margin to be high given their lending rates are high and being an conservative investor, I thought that the share of these banks would offer me a reasonable rates of return. I am deeply disappointed that some of the shares that I own have dropped by more than 50% in value. Should I sell these stocks or hold? How come I failed to be well informed about this development?

Professor: You asked the right question. If you relied on your text books for an answer, you are not likely to find any information current and more so with specific details. This information about NPA has always been available for the last one year. RBI was always insisting that these banks should came out with the true picture of their performance and not hide under the restructured loan which technically is a non-performing asset but an expected delayed performing asset. This is done by extending the loan period and making favourable loan payment schedule.

One of the important aspects of transparency is that the investing public should be allowed to have up to date information on every aspect of the banking operations. Some times in reality company balance sheet overstated the values of the asset that they hold. After all any price discovery involves answering the question, “What the market will pay?’ and people bought and sold at those prices.

Student: How come our text books don’t capture this important information? Seldom books tell us what risks we are?

Professor: The contents of a text book hardly changes except cosmetically over the years. Take any two finance text / economics textbook that was published in the last five years. Save for the writing style and different examples and the so-called abridged cases there is really nothing new added in them. Contemporary market oriented books should contain up to date information. But let us come to the basic issue which is, “why is the NPA increasing steadily?’. Is it because the economy is fairing badly? Is it because the demand for the product or services produced by the company is dropping? One thing is certain. Now that the NPA has become a serious issue, there are many aspects of it, you should become aware of. Specifically when will these assets become performing? How much of banks profit is likely to be written off because of the fallen asset prices? How can the banks find additional liquidity and continue to maintain their profit level? Will the govt. provide a loan or equity to bring back the normal banking operations? In the next few blogs we will explore them.

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