In the recent times, with the economy registering a slow pace of growth, demand for goods and services declining and companies posting poor financial results, the problems faced by public sector banks (PSBs) for recovering their loans has only worsened.

Amongst the loans advanced to various entities including individuals, farmers, priority sector, etc, it is the corporates that have majorly defaulted on repayment. According to the 67th report of the parliamentary standing committee on finance, non-performing assets (NPAs) on loans given to corporates shot up to a whopping Rs 83,490 crore in the last year-and-a-half ending December 2012.

According to the report, which was tabled in Parliament on April 22, all NPAs including corporate loans but excluding priority sector lending amounted to over Rs 84,000 crore of which corporate loans turning bad amounted to Rs 83,490 crore.

In addition, the report highlighted that actual recovery by public sector banks has remained stagnant in the last two years. “The percentage of reduction in NPAs due to actual recovery remains stagnant at 35 percent and compromised write-off and upgradation together constitute 65 percent. It is thus evident that the performance of individual PSBs recovering the NPAs as compared to write-off/upgradation is far from satisfactory,” the report said.

With the consistent rise in the value of NPAs and not-so-effective recovery mechanisms in place, public sector banks have witnessed a slump in profits. As a precautionary measure, banks are required to create provisions for clearing bad debts and this is to be created out of profits earned. Hence, as a greater amount of debts turn bad and debtors continue to delay repayment, banks need to write-off bad debts from such provisions resulting in profit cuts.

Blaming the deceleration in economy for the present situation, MD Mallya, former chairman, Bank of Baroda said, it was “natural” for companies to default on loan repayment. “In the last few years, the Indian economy has not been performing well and hence, the demand for goods and services has gone down drastically. This has negatively impacted the financials of corporates which is why they have not been able to pay back their debts.”

On being asked if banks should take into account the equity holdings of the corporates before lending to them, Mallya rejected the idea saying that high levels of debt were not alone related to increased riskiness of companies. “There are various companies that invest in capital-intensive projects (projects which require large spending) for which they cannot depend only on public funds. They will have to turn to banks for loans.”

Further, he said, certain projects take a longer duration before the company can break-even and start yielding profits out of which they can repay loans and with the present economic situation, companies will only take longer.

Echoing the sentiment, Sangeet Shukla, senior advisor with the Indian Banks’ Association, which has 173 members from the banking community, said, “The situation is a reflection of the real economy which has not been performing too well. It would be unfair to put the blame entirely on corporates as even colaterals provided by them fail when the economy is languishing.”

When asked about the potential risk faced by banks while making advances for amounts exceeding the market capitalization of companies, Shukla said, this was not the only problem. “Market capitalization values are illusionary figures as they also depend on the economic outlook of investors trading in the shares of the economy. Hence, while banks need to consider them before advancing loans, there are several other factors that need to be taken into account,” he said.

In February, the finance ministry had directed public sector banks to step-up loan recovery measures to improve the management of NPAs. The measures suggested included— appointing nodal officers for supervising recovery of loss-making assets, putting in place an early warning system and constituting a committee of board officials for monitoring recovery.

The committee has asked the government to publish names of all willfull defaulters besides suggesting the setting-up of a special NPA management cell for reviewing write-offs /upgrades and monitoring the pace of recovery of NPAs.

Calling for an upgrade of the risk management systems of banks, SS Kohli, former chairman of Punjab National Bank said, “Banks need to carefully examine their lending policy immediately especially because of the poor performance of the economy in the last few years. While lending to corporates, it is important to carry out a detailed study of the sector in which they operate so as to understand the current performance and future prospects of both the sector and the corporate in particular.” In this way, Kohli added, banks can alter their loan exposure for every sector and diversify their risks.

In addition, Mallya said that banks should adopt a focused approach to recovery in which every case of loan recovery should be dealt with separately. “Banks should work with their defaulting debtors in identifying the main reasons for delay in the repayment of loans and select a recovery mechanism suitable to each debtor- periodic settlement, one-time settlement, approaching the debt recovery tribunal (DRT), etc.”

Running blindly behind revenue and growth by engaging in reckless lending will soon result in a crisis-like situation for banks, Kohli warned. “Giving out loans, especially large sums to corporates, without undertaking a proper study of their performance, etc, will lead to banks suffering huge losses. Banks should always aim for sustained growth,” he said.