At the end of 2015-16, according to the RBI’s assessment, gross non-performing assets (GNPAs) and net NPAs (NNPAs) for the banks stood at Rs 6.12 lakh crore and Rs 3.49 lakh crore respectively. The RBI’s latest financial stability report indicates that the GNPA ratio (w.r.t advances) for scheduled commercial banks increased from 9.2% in September 2016 to 9.6% in March 2017, whereas the corresponding ratios for NNPAs were 5.4% and 5.5% respectively.

On the other hand, the corresponding ratios for “stressed advances” (GNPAs + restructured advances) for the same timelines were 12.3% and 12% respectively.

These officially disclosed figures hide more than they reveal. It is widely known how the public sector undertaking banks, under political pressure, have been sanctioning loans for projects on a large scale without exercising due diligence. In the guise of “corporate debt restructuring” and a variety of other debt recast schemes, the banks have allowed the defaulting corporate businesses to have their way and continue to bleed the banking sector. The advances thus given to the corporate houses in different forms and at different stages may not yet have come strictly within the definition of “stressed advances” but they too, sooner or later, will have to be reckoned as such. The NPA problem, unless tackled firmly and immediately, will therefore soon spiral into a crisis that will cripple the banking system and hurt the economy.

Keeping this in view, the government rightly issued an ordinance in May this year to amend the Banking Regulation Act so as to empower the RBI to intervene and trigger insolvency proceedings against the defaulting companies and help the affected banks to recover the soured advances at least partially.

Meanwhile, banks are under pressure to meet the globally accepted Basel III capital adequacy norms by March 2019, which, according to some estimates, will require an infusion of Rs 6 lakh crore of capital into the banking sector.

Tightening the capital norms is intended to improve the health of the sector but it looks as though the ailing Indian banking sector will not be able to adopt the norms as per the timelines globally accepted. The finance ministry and RBI have already started talking of deferring compliance with the Basel III norms. The finance ministry certainly finds itself caught in a catch-22 situation. If Basel norms are not adopted, the banking sector will get exposed to further deterioration. If Basel norms were to be enforced immediately in line with the globally evolving safeguard, the banks would have to trim their financial statements and stop giving new advances to the heavily indebted corporate entities. As of now, it appears that the finance ministry is slowly tilting in favour of the defaulting corporates, not in favour of improving the health of the banking sector, as explained below.

Auction problems

While the NPA problem is developing fast into a formidable crisis, during the last three years, the NDA government also got into the process of auctioning coal blocks and spectrum, with its revenue expectations pegged at levels that would expose the mistakes committed by the previous UPA government which, no doubt, allotted coal blocks and spectrum in a highly controversial and non-transparent manner.

Open auctions have certainly facilitated competition and yielded handsome revenues for the public exchequer. Auctioning of 32 coal blocks to 28 successful bidders during the last three years yielded Rs 2.07 lakh crore of revenues, royalties and upfront payments. Similarly, telecom spectrum auctions in 2015 and 2016 yielded a revenue of Rs 1.75 lakh crore. Thus, the total revenue accruals from coal and spectrum sales were around Rs 3.82 lakh crore, a truly impressive achievement for the present NDA government.

While the government has no doubt earned handsome amounts of revenue from coal and spectrum auctions, to what extent the allotment of coal blocks and spectrum will ultimately translate into tangible physical benefits and value addition for the economy? Can the companies that were successful in bidding for coal blocks invest sufficient funds for developing those blocks and increase coal production for use in the downstream sectors? Similarly, can the telecom companies that won the spectrum deliver the kind of services expected of them?

Coal chimney

Let us first take the case of the successful bidders of the coal blocks to see the extent to which they can raise Rs 2.07 lakh crore and still remain in business to be able to develop the coal blocks upto the expectations of the government.

A quick look at the the financial indices of the 28 companies will show that at least 11 companies who won 14 coal blocks are financially stressed and it is doubtful whether they can service their existing debt, leave alone raise additional loans, run their businesses and develop the coal blocks allotted to them. Among them, three companies already figure among the 12 companies reported to have been chosen by RBI for initiating insolvency proceedings under the latest banking regulation ordinance. A closer scrutiny of the financial statements of the other successful bidders is likely to show that they too have similar debt service problems. Apparently, the coal ministry was in too much of a hurry to auction away the coal blocks for high bid values to have the patience to see whether the bidders have the necessary financial muscle to deliver.

In reply to the concerns expressed on this by the author of this article two years ago, the coal ministry responded in writing on May 27, 2015, stating that “securing finances to operate coal mines is the responsibility of successful bidders. It is for the financial institutions concerned to carry out due diligence while extending credit to successful bidders”. The coal ministry further stated that in the event of any failure on the part of the bidder company to fulfil its commitment, it would forego the performance security equivalent to the aggregate of one year royalty payment.

Everyone knows that the NPA problem has in itself been the outcome of lack of due diligence on the part of the financial institutions. Plagued by the NPAs and the otherwise stressed assets, the banks should, in principle, refuse to sanction any new loans to some of these heavily indebted companies for developing the coal blocks they have won in auctions. If that were to be the case, nearly 40% of the coal blocks assigned to such companies would not get developed for production in the foreseeable future, as the companies to whom they have been allotted will struggle to raise the required finances. This will lead to both time and cost overruns that will impose a heavy cost on the economy. Even if the government were to encash the performance securities for non-fulfillment of the auction terms, considering that the coal royalties are so nominal in proportion to the potential value of coal, the cash value of the securities would be a pittance, compared to the enormous cost that such failures would inflict on the economy.

In other words, if the RBI were to proceed strictly in accordance with the amended banking regulation ordinance, many of the auctioned coal blocks in the hands of the financially stressed companies would remain idle without any production taking place in the near future, defeating the very purpose of auctioning them.

Telecom wires

The telecom sector is in no better position. According to the telecom industry, it faces a debt burden of Rs 4.5-5 lakh crore as of now, whereas the banks place the same at Rs 7 lakh crore. The telecom companies, who won additional spectrum by offering high bids in the auctions conducted during the last three years, find themselves in a worse situation today.

They are now demanding a host of concessions including doubling of the deferred payment period for the spectrum, reducing the interest burden on loans and allowing spectrum to be used as collateral for loans, a move that has been opposed by the telecom department. If these concessions are not conceded, some of the telecom companies that successfully bid for spectrum would fail to deliver. If the concessions were to be conceded, it would amount to post-auction changes in the auction terms, a move that will surely put auction ethics to test and vitiate the credibility of the future auctions. Such a move would also create an incentive for future loan defaults, accentuating the already worrisome NPA problem in so far as the telecom sector is concerned.

One major telecom company, heavily indebted to the banks, has already defaulted in loan repayment but, as player wielding influence over the political executive, it has managed to get a breather from the lenders, an instance that could be cited by the other loan defaulters to get a similar concession.

The finance ministry certainly finds itself in a “run-with-the hare and hunt-with-the hounds” situation. If the ministry is really serious about enforcing the amended banking regulation law in letter and spirit and restore the health of the banking sector, it should allow sufficient freedom to the RBI to treat all defaulting corporates on an equal footing and initiate insolvency proceedings with an iron hand. The ministry cannot afford to discriminate between one corporate house and another or between those that won coal blocks and spectrum during the NDA rule and the other defaulting loanee companies. Any discriminatory approach in this matter will not only erode the credibility of the government in dealing with the NPA crisis firmly but also its credibility in delivering transparent governance. Considering the debilitating impact that the NPA crisis can have on the economy in the immediate future, the government’s options are limited to enforcing the amended banking regulation law strictly and equitably and give the RBI a free hand to proceed in right earnest.

One has to wait and watch the next move that the government makes.

E.A.S. Sarma is former secretary to the government of India.