Twin and four balance sheet problems ‘resolved’ but caution remains the buzzword

The Union Finance Minister Nirmala Sitharaman said a few weeks ago that the ‘twin balance sheet’ problem that banks and corporates faced was over and that the problem had become an advantage, thanks to the steps taken by the government. The twin balance sheets problem, as we may recall, referred to a situation that existed a few years back in which both banks and corporates faced financial distress at the same time on account of the fact that corporates had overleveraged themselves with loans from banks, making it impossible for them to repay, which, as a result became non-performing assets (NPA) and crippled the profitability of banks and their ability to lend further.

The twin balance sheets soon became part of the four balance sheets problem, when NBFCs and real estate got added, following a bout of excessive lending by NBFCs to the real estate sector, leading to both facing acute financial stress.

The twin balance sheets problem was resolved, thanks to the various initiatives taken by the Finance Ministry, under Mission Indradhanush, which is designed to address problems faced by public sector banks. Of critical importance to the twin balance sheets problem was the 4R component of Mission Indradhanush, which aimed at making banks recognize their NPAs and resolving them through various recovery methods, recapitalizing the banks and finally reforming them so as to avoid a recurrence of past problems.

That these measures bore fruit is in little doubt as the records show.

The Reserve Bank of India (RBI) stated in its Financial Stability Report (FSR) that gross NPAs of banks had fallen from a high of 11.6% in March 2018 to 3.9% in March 2023. CMIE has reported that profitability of corporates has improved significantly in the last few years following deleveraging and incentives provided by the Centre. Therefore, both banks and corporates seem to have turned the corner. Perhaps the only blemish is the poor recovery rate of NPAs written off by banks. The RBI has stated that against Rs 5.86 lakh crore written off in the last three years, recoveries amounted to a mere 18.60%.

Insofar as NBFCs and real estate are concerned, RBI’s directive to NBFCs to finance only projects where all approvals are in place has eased their strain, while improved market conditions post-Covid has helped the real estate sector. With this, the four balance sheets problem appears to have become a thing of the past, though with NBFCs, their aggressive growth is coming under minute RBI scrutiny. One of the strategies employed by PSBs to prevent a repeat of past problems is to reduce lending to the corporate sector and focus more intensively on loans to individuals or personal loans and to the services sector. Historically, the highest NPAs and stressed assets of banks were in loans to industry, and the lowest, in personal loans, and loans to the service sector, as brought in RBI’s FSR. Stressed loans to industry were at 12% in September 2021 while they were only at 4% for personal loans and 6.8% for service.

By March ’23, stressed loans to personal were at 2.9% and service at 5.1%, while for industry they were at 6.8%. Stepping up growth in personal and services sectors, by March ’23, personal loans accounted for 31.2% of credit portfolio of scheduled commercial banks, services for 28.1% and loans to industry for 26 %. This represents a significant shift in the direction of bank lending, especially PSU banks, which were previously more focused on industry and really started personal loans only in the last 10-15 years.

This strategic shift appears to be a judicious move by banks; however, it is not without its pitfalls. For one, unsecured loans in personal segment have been increasing, with RBI showing that in the past two years, they rose from 22.9% to 25.2% in this segment. At a time when inflation is high and interest rates have been rising, EMIs have gone up and risk of default has increased. This is being reflected in high defaults in credit card payments and some personal loans.

What is also worrisome for banks is their growing exposure to NBFCs, whose unsecured loans portfolio is high, which indirectly increase banks’ unsecured loans. Unsecured loans in a rising EMI environment could bring a fresh spell of NPAs for banks and NBFCs, which they should be guarded against.

While there is much to applaud over the performance of banks and NBFCs in the last few years, continued vigilance is required to keep the loan portfolio as healthy as possible and avoid mistakes of the past.

(The author is former chairman of Pension Fund Regulatory and Development Authority (PFRDA)