DERIVATIVES

Rough draft on Increasing NPA and its Impact on Indian economy

SUBMITTED TO

DR. ANIRBAN GHATAK

SUBMITTED BY

RAGUL

1627326
Increasing NPA and its impact on Indian economy
Non-performing assets- a measure of sickness in Indian banking system which has an impact on
banking system and economy as well. In India, as of June 2017 (last quarter) there is an increase
of 16.6% in NPAs which is about 8.3 lakh crores when compared to previous quarterly results.
Most of the NPAs are from Public sector banks than the private sector banks, this is mainly because
of the aggressive lending done by PSUs in the past. State Bank of India accounts 22.7% of the
total NPAs and the main credit defaulters are large companies and SME. As a fact, Government
of India is written-off bad debts using public money and the profit generated will be transferred to
GOI. This in turn is the ineffective use of people money. In our democratic economy, there is a
need of quality education and the investments for that, but because of the increased NPAs there is
write-off happening by GOI which spends tax revenues in this sector.

Coming to the historical NPAs in India, there is a high credit growth from 2005 but it fell
drastically in 2008 because of the global financial crisis where the NPAs growth was higher than
the credit growth mainly because of the governance issues with the public-sector banks. During
crisis time, the high growth of corporates was funded mainly with debt and there was an increase
in money inflow as well. All of a sudden, the hypothesis on the land price went down and NPAs
increased to 40% mainly in infrastructure and textile companies.

There are many reasons which influences the increase in NPAs such as management activities,
classification of borrowers assets, lack of corporate culture, non- transparency of firms policies,
dilemma in choosing the right measures for both creditworthiness and borrowers performance.
The main reason is the management activities, if the smaller banks plans to lend they will start
with the background check for which they approach the leading banks. The background and
creditworthiness are measured by leading banks and NPAs starts accumulating from this step
because the creditworthiness should be measured by the respective banks with the help of credit
scores. This activity facilitates the formation of NPAs in long term basis and this mismanagement
creates the direct proportionality between NPAs and Banks profit which is a alarming signal for
whole banking system. Some minor reasons will be the fraudulent activities done by companies
where they so fake their values in the financial statements and banks end up with not doing proper
checks with the past performance and the actual worth.
For ease of understanding the impact of NPAs, let us assume the bank XXX with total capital of
Rs.1lakh and the initial number of borrowers is 10. So, the loan amount for each individual or a
company is Rs.10,000. Bank provides loan at 10% per annum and the total gross profit per
borrower is Rs.1000 and assume the banks expense are Rs.100 and the amount need to be paid to
depositors is Rs.4000(4% of the total capital). In this case, we assume that each borrower will pay
the interest amount at the maturity. So, the net profit for bank is Rs.5000 (10*100-1000-4000).
Now, assume two of the borrowers went default by not paying their interests and principal as well,
then the total profit will be Rs.3000 (8*100-1000-4000). If two borrowers went default i.e. 20%
NPA then there is a 40% reduction in profit. Earlier the banks asset was 10000 now it got reduced
to 8000. The decrease in banks asset reduces their lending capacity and it also affects the recycling
of credit amount because of non-payment of principle and interest amounts. This is the best
example of aggressive lending where there is no correct measure of credit worthiness of a
borrower. The developing economy like India is always depends on MSMEs since it facilitates
production of new goods and products, employment opportunities and contribution towards
exports.

The lending to the priority sector by banks without effective analysis of the credit repayment has
paved way for the increase in the NPAs of the banks. The measure to consolidate the banks have
shown rise in the value of the assets carried on but the base of the balance sheet is shaken from the
decrease in the asset quality. The measure of merger of wealthy banks with unhealthy banks would
reduce the benefits of the synergies as seen in the case of Bank of America merger with Merrill
Lynch reduced the future value of asset of BOA. The capital infusion into the banks are a sign of
inability to sustain and the government should infuse the capital to make the balance sheet healthy
and then consolidate the existing PSU from 21 to 15. The impact of the BASEL norms and the
compliance with the IFRS have resulted the banks for transparent represents and the increase in
the strength of the balance sheet of the banks. The scheme of privatization of the banks gives
autonomy to the banks for effective management and increase the capital base on their own ability.
The economy would sustain as the systematic risk of the banks would be reduced to a maximum
extent and the effective control of the NPAs with these factors mentioned above can be achieved.
The effective management of the banking sector would enable RBI in controlling the inflation and
currency stabilization. The induction of HDFC bank into the group of too big to fail banks showed
encouraging signs for the strength of the Indian banks in the economy growth.
TURNITIN REPORT