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NPA in India: RBI needs Basel norms as its defaults are higher

Given how non-performing assets at state-owned lenders have ballooned to more than 10% of their total advances, and the precarious financial positions of at least 11 lenders, it is surprising the government wants capital adequacy norms prescribed by RBI to be diluted. Specifically, the government believes RBI’s prescribed CRAR of 9%, as compared to the 8% as required by the Basel norms, is too high. It might seem an unnecessary cost at this point but it is actually an investment to keep a crisis at bay. While it is true that banks are now following stricter provisioning norms for stressed assets as compared to what they were doing earlier, it is nonetheless necessary for them to set aside more capital than their counterparts in other countries. That is because, as RBI deputy governor NS Vishwanathan, has explained, the losses tend to be higher in India.
To be sure, there is some improvement post the IBC (Insolvency and Bankruptcy Code) and the rollout of RBI’s revised framework for stressed assets. Nonetheless, Vishwanathan has argued that, given the kind of default behaviour observed in India, applying the Basel-specified risk weights would understate the risk levels of the assets on banks’ books. Studies show the probability of a non-default rating—assigned by the credit rating agencies—turning into a default rating within a certain period of time is higher in India. Also, the track record of ratings agencies leaves much to be desired, as can be seen from the recent case of IL&FS where the company was rated default almost overnight. So, relying on credit rating agencies would probably not be wise. As Vishwanathan points out, a smaller capital base only makes banks more vulnerable to defaulting on their obligations in the event of unexpected losses. Adequate levels of capital need to be maintained and the higher the capital, the more the skin in the game for shareholders.
Potentially, this results in better appraisal of credit and screening. Indeed, until the Asset Quality Review (AQR) was initiated in Q4FY16 by RBI, stressed assets were not classified properly and consequently hugely under-provided for. The upshot was an increase in loans by banks which did not have the required levels of capital and 11 of these needed to be brought under the prompt corrective action (PCA) framework. The government must understand how precious capital is—and this is entirely the taxpayers’ money—and that it cannot simply be frittered away. Since 2005, the government has needed to infuse more than `2.3 lakh crore in PSBs, more than half of which has gone into banks under the PCA framework. Had the capital adequacy norms been tighter all these years, things might not have come to such a pass. It is understandable that the government should want more credit growth in the system, and to that extent, the PCA norms look like they are hindering credit growth; and, after the IL&FS debacle which has hit lending by NBFCs, this growth will be further constrained. But, as the credit growth data shows, the larger banks—including the privately-owned ones—have raised their lending and, as a result of this, India’s overall bank credit growth is quite robust. Unless the government has very good data on the probability of default behaviour in India being much lower than what RBI says, it simply has to let the regulator do its job. And since this results in banks remaining solvent, the Central government should want this even more than RBI.