August 07, 2018

IMF published staff report and selected issues report under the 2018 Article IV consultation with India. Directors stressed the need to focus on macro-financial and structural policies, also welcoming a range of complementary initiatives taken to address high non-performing loans in public-sector banks (PSBs). They underscored the importance of accelerating the implementation of these initiatives, backed by a comprehensive plan to improve the governance, internal controls, and operations of public-sector banks, including by considering more rapid withdrawal of public ownership.

The staff report highlights that the RBI’s Asset Quality Review (AQR), which was initiated in 2015, improved recognition of non-performing assets (NPAs), especially in PSBs, which account for about 70% of the banking system assets. So far, 11 PSBs have been put under the prompt corrective action (PCA) framework that became effective in April 2017. Meanwhile, system-wide capital adequacy has continued to improve and remains above the minimum requirements. Nevertheless, PSBs continue to report low profitability, high NPAs, and increased provisioning, related to the reclassification of their loan portfolios, which remains a constraint on credit expansion and investment. Consequently, the NPA ratio for the banking sector increased to 11.6% in March 2018, compared to 9.6% a year ago, largely reflecting the migration of restructured loans to NPAs and in line with the new framework of RBI for the restructuring of stressed assets. A range of complementary initiatives has been taken to address India’s twin balance sheet problem and resurrect PSB’s financial intermediation.

In addition to the AQR, recognition of NPAs, implementation of the new PCA framework, and PSB recapitalization, RBI directed banks to refer two batches of large corporate accounts in July and December 2017, representing about 40% of PSBs’ outstanding NPAs by value, to the time-bound resolution process under the Insolvency and Bankruptcy code (IBC). Five of the 12 accounts from the first batch are now resolved or nearing the final stages of resolution. Ongoing efforts to build institutional capacity for the effective functioning of the IBC are welcome and could be complemented with designing an out-of-court regime that offers a flexible, speedy, and low-cost alternative to the in-court process under the IBC. In recent months, the RBI introduced a new, simplified framework for the resolution of stressed assets. The new framework involves a more proactive approach in identification, monitoring, and supervision of problem assets and their reference to the IBC process. Banks have begun to reclassify a large share of restructured loans (for example, PSBs reduced these loans from 2.7% in September 2017 to 1.1% of total loans in March 2018) as NPAs, pushing up the NPA ratio further. The higher provisioning coverage (40% required for NPAs compared to 5% for restructured loans) will cause weaker PSBs to continue to report losses in the coming quarters.

Although important steps have been taken to improve the recognition of NPAs and recapitalize PSBs, but more needs to be done. IBC has the potential to significantly improve NPA resolution and corporate debtors’ repayment discipline. The recent large fraud at Punjab National Bank—the second largest PSB—underscores the importance of steps needed to improve PSB governance, internal controls, and operations, including by considering more aggressive disinvestment. Financial markets were generally robust through early 2018—especially equities. Market sentiment, however, has deteriorated in recent months, in line with increased global volatility. Staff encourages the authorities to follow up on the FSAP recommendations, including to amend the legal framework to provide RBI full regulatory and supervisory powers over PSBs to make banking regulation and supervision ownership-neutral.  Additionally, the strong growth of credit to households from private banks and non-bank finance companies calls for vigilance on the part of RBI supervisors, to make sure that these institutions uphold underwriting standards.

The selected issues report examines the potential trade-offs of simplifying the Goods and Services Tax, the deteriorating finances of states, and the structure and composition of Foreign Direct Investment flows to India.

 

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Keywords: Asia Pacific, India, Banking, NPLs, Prompt Corrective Action, Article IV, FSAP, IMF

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