THE magnitude of India’s bad loans is much worse than the banks are willing to admit. This has squeezed banks’ profits and consequently made it imperative for banks to recover debts that could be bigger than New Zealand’s $170 billion economy. This was revealed last month when two of India’s largest private sector lenders provided a full disclosure on nonperforming loans. This lends credence to RBI Governor, Raghuram Rajan’s repeated warnings to the banks to clean up their balance sheets. When banks make provisions to cover the losses from bad loans it begins to hurt their profits and to curb credit growth thereby unleashing a vicious circle of lower economic growth and triggering more defaults and choking off business investment and production. Bank loan growths in March 2015 stood at only 10.7 % and was the slowest in nearly two decades, partly on lower lending to debt-heavy sectors such as iron and steel that account for the lion’s share of bad debt. Profits at most lenders have also taken a hit in the past six months as they set aside a higher sum to cover for defaults after a clean-up exercise was ordered by the RBI.
Financial experts estimate that about 13 trillion rupees ($195 billion), or a fifth, of bank loans are already stressed. The RBI chief now wants banks to fully disclose and provide for bad debt by March 2017 in what he calls a deep surgery to clean up the balance sheets. Investors and analysts have long suspected that Indian lenders, especially the dominant state-run banks, are not disclosing the true extent of their troubled loans to avoid having to raise provisions. Only when ICICI and Axis banks released granular details last month was the problem highlighted. State-owned banks account for more than two-thirds of the sector’s assets and about 85 percent of bad debts. This is a major challenge for policymakers keen to support a slowing economy. As financial experts say, it will only get worse before it gets better. But the question is how the banks were able to camouflage these huge liabilities. And what about the regulatory mechanisms and the ombudsmen who are supposed to keep watch on the propensity of banks to lend arbitrarily? These are troubling questions indeed!