It should be noted that the Public Sector Banks (PSBs) recorded an improvement in their performance in FY22. Out of 12, 11 reported results and most of them reflect an overall improvement in terms of capital ratio (CAR), asset quality and profitability and many other parameters.
Many of them have increased the provision coverage ratio (PCR). SBI’s gross non-performing assets (GNPA) stand at 3.97%, Bank of Baroda at 6.61%, Canara Bank at 7.51% with their corresponding PCR at 90.2%, 88.71% and 84.17%, respectively, in March 2022 reflecting a marked improvement in asset quality. As part of improving asset quality, a higher PCR allows banks to bear losses in case they become uncollectible.
Although some loans delinquent due to Covid-19 had to escape classification under the RBI’s restructuring plans, they did not jeopardize the improvement in asset quality. To drop GNPAs from as high as 14.6% in March 2018 to 7.5% by March 2021, which could drop further in March 2022, is indeed impressive. But upside risks cannot be ruled out due to continued macroeconomic volatility and lingering geopolitical risks.
The next challenge for PSBs would be to maintain this pace of improving asset quality, which will require continued efforts to strengthen credit risk management (CRM). Better application of technology in CRM, systemic improvements in credit provisioning, monitoring and debt resolution will be important steps.
Technology-intensive innovations in credit management techniques and gradually tightening regulations have strengthened the asset quality ecosystem.
As components of CRM, the quality of credit origination, rigor in credit monitoring, timely use of onboarding processes (restructuring facilities) to bail out temporary borrower disruptions depend on internal systemic efficiencies and loan portfolio monitoring tools built over a period of time. It also depends on how the three lines of defense of the CRM are reinforced.
The galvanization of technology, support for data analysis, market intelligence in granting credit, rigor in proactive monitoring, systemic controls, maintaining credit quality and compliance standards will depend on related policies and people efficiency.
Maintain credit quality
Given the limitations inherited from the past, the diversity of borrower profiles and the geographical reach of PSBs, CRM systems are evolving to improve asset quality. But how it can be sustained long-term while balancing short-term challenges is a moot point.
With Special Mention Account (SMA) data and Central Large Credit Information Repository (CRILC) information for loan accounts over ₹50 million made available to bank branches, the reach credit monitoring has improved considerably.
Debt resolution and the effectiveness of DRTs and NCLTs are work in progress, aligned with the dynamics of the business environment for banks and borrowers.
The two important parts of CRM—(i) monitoring credit quality and (ii) resolving debt after loans become nonperforming assets (NPAs)—are post-sanction activities. Rigorous monitoring and ensuring the recovery of NPAs are the only options.
But the most important part of CRM – the methods of sourcing new credits – is still controversial, subject to improvement, and its nuances are still debated. It constantly evolves with the markets. The quality of credit origination depends on three distinct sources of information: external information from rating agencies and industry sources, information provided by the borrower and, finally, market information used in the credit assessment by banks.
CRM governance must be aligned with lending policies, regulations and exposure standards leading to credit decision.
Ensuring the creditworthiness of new loan accounts is key to keeping asset quality intact. This is why it is important to calibrate risk assessment standards to filter out poor assets and acquire a solvent portfolio.
Norms and standards for credit assessment and the resulting credit decision will need to be tailored to the strengths of the organization so that its monitoring and collection over the life of the loan asset can be enforced.
In the early 2000s, PSBs lent aggressively to companies for building infrastructure, particularly for power generation, steel, and telecommunications.
This led to a surge in restructured assets, which led to a pile of NPAs after RBI waived forbearance on loan restructuring and proposed an asset quality review (AQR). PSOs need to learn from this experience and define their own sector risk appetite.
Instead of being completely driven by industry demand, CRM should be well aligned with internal forces establishing microprudential standards capable of weeding out potentially distressed assets.
The effectiveness of PSO GRC would lie in a differentiated approach by taking sector exposure for new loans instead of adopting uniform asset acquisition in line with peers.
A classic example in the current environment might be the growing exposure to retail lending and the use of risk-sharing opportunities with non-banks. These are good trading opportunities, but increased exposure to them may not be suitable for all PSOs. At the same time, like much of CRM, people skill building, procedural reforms in credit reporting, and the use of technology in assessment need to be upgraded.
Personalization of the composition of the credit portfolio
Compliance with regulatory standards should not limit the ability of PSOs to define their own risk appetite. The sustainability of asset quality will depend not only on resolving the debt of GNPA’s existing stock more quickly, but also on preventing a group of high-risk assets from entering the portfolio.
Before the new tranche of credit is absorbed, PSBs will need to consider the future implications of the cost and ability to track these loans, examine the state of borrowers’ digital literacy to respond to the use of technology by banks in credit monitoring.
Asset quality is the result of the work of a combination of stakeholders, but the vision and foresight of lenders is of great importance in maintaining competitiveness in the markets.
Introspection into the composition of the credit portfolio and timely political intervention can pave the way for long-term asset quality management.
The author is Adjunct Professor, Institute of Insurance and Risk Management, Hyderabad. Opinions expressed are personal
May 26, 2022