The Financial Stability Report published recently by the Reserve Bank of India states that the asset quality of scheduled commercial banks seems to be much better than those estimated in the previous FSR (January ’21), which had projected alarming numbers of 13.5 percent (base scenario) and 14.8 percent (extreme scenario) by September ’21.
It also states that banks are expected to remain well capitalised and can sustain a severe stress scenario. These undoubtedly are the positives.
The FSR, however, also pointed at some negatives, which are as follows
§ Government finances are stretched, with income shortfall due to lockdown induced economic inactivity and increased expenditure on health and welfare
§ As per the RBI’s stress tests forecast, Gross Non-Performing Asset (GNPA) levels of scheduled commercial banks are likely to rise substantially from 7.5 percent in March ’21 to 9.8 percent (base scenario)/11.2 percent (extreme scenario) by March ’22
§ Credit growth continues to remain muted while deposit growth continues on account of precautionary savings
§ Rising incidence of data breaches and cyber-attacks is an additional cause for concern with remote working and increased digital transactions
In other words, while the financial system is better placed with capital and liquidity, risks are also heightened, both in quantum (burgeoning NPAs) as well as in nature (new kinds of risk including cyber risk). These necessitate proactive risk management strategies from financial institutions as well as the government.
The authorities assume heightened levels of stress in the banking system post the pandemic, as is evident from the outlook given in FSR. They have been monitoring the situation and are coming up with measures from time to time (Please see table below), the latest ones being setting up of a bad bank and announcement of moratorium of upto two years to individuals and SMEs with exposure upto Rs. 2 crore that did not restructure their loans in 2020 and was classified as standard accounts till March 2021.
Actions taken towards restoring normalcy post the pandemic
It is well-known that the measures taken so far from identifying bad loans way back in the nineties to asset quality review done by the Reserve Bank of India in 2015 have yielded minimal results except that now we know the extent of the malaise. The reasons for little success in NPA resolution are many, the main being the law in the country takes far too long to recover the money as disposing of bad assets is a time-consuming process. Obviously, the law needs to be reframed to bring in expeditious resolution of stressed assets.
Apart from this, the approach to recovery also needs to change. The solutions so far have dipped into the same pool of money, that is, the banking system, be it write-offs or ARCs buying bad assets. Unless there is fresh money coming into the system by way of say ARCs raising funds directly from the market rather than using their own equity funds given by the government or the banks that have set them up.
This of course is the ground-level scenario. And not much will change unless the authorities actively try to find real solutions rather than tinkering at the margins. Given this impasse, should we look at the very root cause of the issue to see if that can be managed? When we are talking of digital invasion in every field, even more so in these days of the pandemic, can technology show a way in tackling the banks’ NPAs?
The answer is a resounding affirmative. Technology can not only help banks track the NPAs on almost a day-to-day basis but also guide them through possible actions to be taken. There are products available globally and also in India that can help banks and NBFCs track and thereby reduce NPAs. In fact, there are product portfolios that address all types of risks that a financial institution faces – like model risk, operational risk, technology risk and, liquidity risk and give early warning signals and help quantify risk in likely scenarios.
Credit Risk products, for instance, enable banks to holistically observe borrowers at different checkpoints over the loan lifecycle, rather than taking a point-in-time approach. Model Risk Management products can help manage the lifecycle of models used in a bank. Today, for example, an average bank uses 2500-3000 models to manage its business. Most of the banks - both globally and domestically - manage these models in Excel sheets. Managing these models is in fact the biggest problem banks have after NPA management. Regulators have therefore brought in the concept of Model Risk Management.
Enterprise Risk Management is a powerful product that helps banks identify and control risks arising out of banking operations. Asset Liability Management is yet another product that helps banks address the risk faced by them due to mismatch between assets and liabilities which can occur either due to changes in liquidity in the system or changes in the interest rates.
There are products in the market that help banks accurately estimate the estimated credit losses before the actual losses take place and thus help manage them better - not only on their balance sheet but also in terms of communicating the numbers to their stakeholders. Web technology now enables proactive and simultaneous tracking of internal as well as external factors that may affect borrowers’ repaying capability and predict their propensity to default. They can track incipient stress, weakness, credit fraud, and probable NPAs.
Products assign the grades on the basis of which banks can take required corrective action, such as, put borrowers on the watch list, reduce exposure or enhance collateral, or even exit from the loan. Two added advantages of such products are: banks can focus on credit growth - their primary function and improve regulatory compliance by identifying stressed assets in line with central bank norms. This can ultimately result in cost savings for the banks.
This is a reality as banks in the US, UAE, and several Indian public and private sector banks have already deployed such products and are reaping the benefits (See table below). Clearly, technology is the way to go for NPA management of the Indian financial system.
Author Jaya Vaidhyanathan is CEO, BCT Digital, global speaker, entrepreneur, thought leader, and a fintech aficionado. Views expressed are personal
(Edited by : Kanishka Sarkar)