Banks must bank on MSMEs - Q3 FY18 banking review, the NPA mess and the resolution process

By Alastair Pavrey

The banking sector has always been in the spotlight, for good or bad. Considered a backbone of the economy, the integrity of the institutions has been questioned due to various issues, ranging from the exponentially increasing Non-performing Asset (NPA) woes to the recent frauds making waves around the finance community. Let us look at how the sector performed in Q3 FY18, the NPA situation and how it is being resolved and finally why the MSME sector is emerging as a good proposition for banks to expand their loan portfolio, while significantly reducing the risk of “bad loans”.

Banking Sector Performance Q3 FY18

As per CARE Ratings, the performance of banks continues to be stressed in Q3-FY18 as revealed by the performance of a sample of 30 banks which includes 13 PSBs and 17 private banks. Profits are under strain and the NPA issue continues to pressurize banks.

·      Growth in interest income in Q3-FY18 was 8.9% as against 2.3% in interest expenditure attributed to higher growth in bank credit. Growth in deposits was lower at 4% compared with 14.6% last year ·      Net Interest Income increased by 22.4% against negative growth last year attributed to both higher growth in credit and lower decrease in lending rates ·      Growth in operating expenses was 10.7% which is lower than that of 16.7% last year

·      A major setback was the decline in other income primarily due to the rise in yields on investments which affected the P & L due to the MTM losses that were booked ·      Provisions increased sharply by 69.1% as against decline last year. Net profit growth declined to a loss from a profit position in Q3-FY17 ·      Gross NPAs continued to increase by 34.5% in Q3-FY18 on top of 59.3% last year. NPA ratio touched 9.45% from 8.34% in Dec 2016

Comparison between PSBs and private banks

- Private Banks also witnessed higher growth in both interest income and expenses while PSBs were affected more perceptibly by the decline in other income.

- Growth in operating expenses was almost on par, with PSBs being slightly higher.

- Private banks have witnessed growth in net profit while PSBs have witnessed a loss of around Rs 11,000 cr owing to increase  in provisions

- Private Banks maintained the Gross NPA ratio at 4.15% over 2016 which was however higher than 2.51% in 2015.

- PSBs witnessed higher growth in NII.

Note on PSUs

CARE also analyzed 30 Public Sector Undertakings (PSUs) across industries. The study examined these sectors/companies on parameters over the last 5 years and compares them with their peers in the private sector to provide insights on their financial and operational efficiency.

Key Takeaways:

-          Interest cost has not been significant and at comfortable levels across companies barring the case of Air India and Steel Authority of India limited. However, all other PSUs covered under this report have an interest coverage ratio greater than 1.

-          Revenue growth especially across sectors like trading, aviation, shipping and capital goods has been slower compared with their private peers. For companies that operate in capital intensive sectors, lower revenue growth has led to reduced operating margins over the years in comparison with private peers.

-          A big differentiator between PSUs and private companies has been employee cost. The cost difference was sizable in labour intensive sectors like mining, mineral & metals, capital goods and shipping.

Non performing assets: An itch that just won’t go away

The rising NPAs or “bad loans” that emerged around 4 years back due to the reasons such as careless lending, lack of proper due diligence and persisted since companies are unable to efficiently pay down debt. In layman terms, banks have lent about 8-10 lakh crores to businessmen that aren’t likely to be re-paid. It means that nearly 10% of all the money lent may not come back.

NPA resolution in India is understandably complex, tedious and time consuming. The World Bank’s Doing Business 2018 report reveals that in terms of insolvency resolution, India holds a dismal 174th rank out of 212 countries. Further, it takes 4.3 years, on an average, for any resolution. Even economic laggards such as Latin America, South Asia and North Africa take between 2.9, 2.6 and 1.7 years, respectively.

The current NPA scenario can be summarized numerically as follows:-

-          Presently, the banking sector’s gross non-performing assets is close to Rs 9 lakh crore.

-          The gross NPA figure is expected to touch Rs 9.5 lakh crore by March 2018. By that time, banks will have to provide for the NCLT II cases which will keep the provision elevated.

-          With the new RBI guidelines, close to 2-3% of advances that was part of the various restructuring dispensation will now have to get recognized as NPAs. This might add an incremental Rs 2.5 lakh crore to the existing NPA pool, requiring incremental provision of the order of Rs 1.25 lakh crore.

-          The government’s recapitalization dose of Rs 2.11 lakh crore may actually fall short.

Need for better risk assessment - Enter the IBC Code

India only recovers a mere 26% of its stressed assets compared to 92% by Japan and 81% by Germany. (PwC)

By December 2017, at 9.9%, India became the fifth largest in term of countries with bad loans, according to CARE Ratings. However, as compared to June 30^th 2017, when the bad loans were at Rs 9.5 lakh crore, they dropped a little to 9.46 lakh crore by September 30^th 2017. The reason for this drop, at a time when bad debts are rising, is attributed to the implementation of the Insolvency and Bankruptcy Code (IBC).

The law was initially passed in 2016 and has now gone through various iterations, one major change being the introduction of Section 29A in the IBC provision to plug the loophole that allowed promoters to bid for their companies back at a discounted price, although this decision is still up for debate as all promoters may not have mismanaged loans due to incompetency.

Its true implementation kicked in real terms only when the Reserve Bank of India identified 12 big corporate accounts, responsible for 25% of total bad loans, for immediate resolution. It also identified 488 other accounts that were given six months’ time to standardise their debt. By December 2017, about 28 more accounts were identified for resolution under IBC in the National Company Law Tribunal (NCLT).

Some good news though, for the first ten cases under the Insolvency and Bankruptcy Code (IBC) between August and December 2017, financial creditors were able to recover 33.53% of total claims outstanding from the defaulting borrowers.

The recovery rate for the 10 cases under the IBC for which resolution has been approved is better than overall rate recorded for banks, although these are early days and the large cases of default are yet to be resolved. Various grey areas within the law need to be ironed out to improve the process on the whole.

Some further reforms

-          RBI issued a notification subsuming 28 schemes, laying down strict and uniform framework on loan defaults to simplify the processes further. Processes like Corporate Debt Restructuring Scheme, Joint Lenders’ Forum (JLF) and Strategic Debt Restructuring Scheme (SDR), have been removed.

-          Banks have also been asked to identify accounts as NPA immediately on default. The lenders and borrowers have been given a 6-month deadline to repay loans or face insolvency under the IBC.

-          The RBI has also warned banks against ‘evergreening’ (concealing the actual status of any account), and has asked for weekly disclosures till March 31 and monthly from April 1 on the status of defaults to the RBI credit registry.

The various reforms can lead to harmonizing the resolution process leading to greater transparency, credibility and efficiency.

 The MSME Opportunity: Duality of existing credit gap and overall sentiment

MSMEs not only contribute significantly to the country’s GDP, but also generate large scale employment across the nation. The Economic Survey 2017-2018 clearly shows MSMEs are handicapped by a dearth of credit to expand their businesses. Contributing 32% to the country's Gross Value Added (GVA), MSMEs also pave the way for industrialization in rural and backward areas.

This is significant since according to the National Sample Survey (NSS) (2015-16) there are 633.8 lakh unincorporated non-agriculture MSMEs that are also providing employment to 11.10 crore workers in the country, but the percentage or credit they receive is not in commensurate.

The recently launched CRISIL-SIDBI MSE Sentiment Index, captures the sentiment among micro and small enterprises (MSEs) on the business environment and their expectations for the next quarter (Survey was conducted in November-December 2017). CRISIL interacted with 10 lenders, including banks and NBFCs, for their views on the MSE sector.

-          Lenders hold a favorable view for the next quarter with 9 out of 10 saying the overall business situation will improve.

-          As for NPAs in the last quarter, 8 out of 10 lenders did not find any change in the situation of MSE accounts, while 2 believed NPA accounts had increased. In the next quarter, 5 out of 10 lenders expect a decrease in NPA accounts, 3 believe it will remain unchanged, while 2 believe it will increase.

-          Overall, however, there is optimism. As per lenders, access to institutional funding remains a challenge for MSEs, as 5 out of 10 believe it is difficult for them to get loans, 2 believe it is neither difficult nor easy, while 2 believe getting a loan is easy.

Also, a slew of reforms announced by the Government make the MSME sector favorable for lending. Check out the reforms announced in our previous MSMEmitra article here.

You can also find out the industry and need specific schemes and subsidies here.

Banking is entering into a new era with a more structured, stringent and quicker resolution process to tackle the mountain of bad loans which has now shifted the focus of banks to diversify their loan portfolio going forward, to avoid similar problems. The MSME sector is one such area of focus that can have a multiplier effect on the economy and a trend is already emerging not only from banks but also from NBFCs and Fintech lending companies, which have realized the financing potential of the sector. The reforms pushed by the Government and the RBI together hopefully will act as a catalyst to the MSME funding space.

As the policies of banks and NBFCs become more favourable for MSMEs, find out the Maximum Permissible Bank Finance for your business here.

MSMEmitra.com specializes in providing funding solutions (Debt Funding and Private Equity Funding) to businesses of all sizes. Our services include – assessing the actual funding requirement, finding out the best funding option available and in sourcing funds. If you are a business owner, and need our assistance for the funding requirements of your business, connect with us at support@msmemitra.com

Make an informed decision about the best funding options available for your business, and find out how to avail the benefits of the schemes and subsidies applicable for your business, by visiting https://msmemitra.com

Thank you for reading.

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About the Author: Alastair Pavrey is a Finance and Investment professional experienced in transaction-based financial advisory to buy-side and sell-side participants, with a keen interest to understand and contribute to the Indian Private Equity, Venture Capital and SME ecosystem. You can follow Alastair Pavrey on Twitter - @alastairpavrey.

Disclaimer:

The views expressed in the article are the author’s own. This write-up has been collated from various publicly available materials and secondary data, and MSMEmitra.com cannot guarantee the accuracy of the content. The opinions and expectations arrived at in this article, are based upon the analysis of the Industry by the author and the editorial team at MSMEmitra.com. Readers are requested to check the authenticity of the data at their end, before making any decisions with inherent financial risks.