NPAs (Non-Performing Assets) place serious burdens on lenders, the most obvious of which is a reduced cash flow impacting budgets and disrupting earnings. For the most part, they greatly restrict an organisation’s ability to lend subsequent loans and must eventually, be written off. The most common NPAs are term loans, with overdraft and cash-credit defaults making up a significant minority.
NPAs are a scourge in the banking industry and a direct consequence of mismanagement and failure on several levels. India, in particular, has garnered a reputation as a country where these instances are commonplace, and this notoriety is not without reason. As of 2018, it is estimated that the gross value of NPAs in all Indian banks amounted to a total of Rs. 8,40,958 crore, or upwards of USD 122 billion.
A sizeable majority of these NPAs were held by PSBs (public sector banks). These included the State Bank of India (the country’s largest lender) at Rs. 2,01,560 crore, the scandal-ridden Punjab National Bank at Rs 55,200 crore, and the IDBI at Rs 44,542 crore. In response to the justifiable public outcry, the Reserve Bank Of India (RBI) recently announced a Prompt Corrective Action (PCA) framework to preserve the financial health of 11 key PSBs. Now whether or not these measures will be effective is yet to be witnessed.
NPAs represent a significant, even existential threat to the proper functioning and integrity of India’s banking system. While RBI reforms are necessary, real change will only manifest when the industry itself is able and willing to relook at every aspect of credit and customer evaluations. If the future of banking in India is to be one without loan defaults on such a massive scale, the following points must be understood and adopted in a comprehensive and substantive manner:
Rely on Objectively Verified Information
Upon close inspection, it’s fair to say that most major loan defaults occurred as the physical validation of stocks, assets, and infrastructure on an on-going basis was not conclusively undertaken, with too much reliance placed upon what appeared on paper.
This essentially means that the banks relied on upon often inflated and sometimes fictitious statements by the borrower, without properly verifying the authenticity of their declared assets. It’s this philosophy of blind ‘trust’ that resulted in the famous PNB Scam of 2017. To reduce the instances of NPAs caused by incorrect assessments of a borrower’s creditworthiness, banks must conduct thorough, an on-ground investigation into all declared assets to verify their authenticity, both before issuing loans and then, at periodic intervals, regardless of the applicant’s reputation.
Avail The Expertise of Third Party Professionals
Third party expertise is often underutilised. Much emphasis is placed on the competence of internal banking staff in separate departments, struggling under the same system to meet common business numbers. Any system where loan applications get verified by the same people who stand to gain if they are approved, regardless of the applicant’s ability to pay, is inherently flawed. This can be easily mitigated by allowing reputed external agencies to screen applicants, while internal banking staff focuses on client acquisition. Throughout the western world, there are multiple levels of third-party diligence that are built into the credit system. In India, while third-party diligence is done for retail lending, it is largely missing in the corporate lending space.
Emphasise More on preventive Risk Management than Post Incident Audits
A stitch in time saves nine, and this adage has never been truer than for the banking industry at present. The current system is largely placing its reliance on audits which is a post-mortem activity. A paradigm shift is required to make risk management an integral and continuous part of the process. Scientific sampling and predictive algorithms can identify accounts long before they become stressed assets. What is important is to come back to the basic fundamentals of fraud itself. Risk and fraud enter any system when opportunity meets intent. A stronger focus on tighter credit processes minimises opportunities, while a robust people-risk management works on mitigating the intent. By integrating both of these facets into the system, one can conceivably reduce cases of frauds or misappropriations. Employee background screening and annual profile assessment tools linked to the annual declaration of assets will go a long way in this regard.
While India is still reeling under the current NPA crisis, which was largely skewed towards corporate lending, there is yet another calamity looming on the horizon concerning the retail segment pertaining to education loans. We believe it may become the next tsunami to ravage the already wounded banking system. Corrective measures and strong intent will need to be seen from the banking leadership in order to mitigate its effects, while a stronger third-party diligence in the credit process is urgently required. Investing in new ways to tap into the widespread, readily available data and integrate it into one system through Blockchain technology, coupled with collaborative efforts by nationwide on-field experts is proving to be the ideal solution to minimise future exploitation of the banking system.
Views expressed in this article are a personal opinion of Hitesh Asrani, Founder and Director, CRP Risk Management.