The Bad Boy Among Bank's NPAs Since the rising percentage of NPAs with banks is fast escalating into a crisis, smaller companies are set to face tough times getting a loan approved

While banks continue to reel under the pressure of reducing their burgeoning non-performing assets (NPAs), the biggest loser may eventually turn out to be the MSME sector which already is the most vulnerable category.

The Crisis

Recently, the biggest taxi aggregators in India - Ola and Uber had a jolt to face when banks refused loans to drivers plying on their platform. According to reports, payments over a fifth of these loans (20 per cent) in Bengaluru, amounting to Rs 60 crore have been defaulted, while in cities like Hyderabad and Chennai, the average rate of loan defaults remain 7 per cent.

Since the rising percentage of NPAs with banks is fast escalating into a crisis, smaller companies are set to face tough times getting a loan approved. A data released by RBI says till March 2016, public and private banks together accounted for more than Rs 6 lac crore of bad assets which has continuously grown over the last four quarters to reach Rs 6,97,409 crore in December 2016.

While demonetization widely has been blamed to have aggravated the problem, the fact is that over the last three years, the volume of NPAs with all banks has seen a continuous rise. For example, bad loan with state-owned banks surged 56.4 per cent in the 12-month period ending December 2016 and for all the banks, bad loans have risen by 135 per cent in last two years.

Out of this magnanimous figure of Rs 6.9 lac crore of NPAs with banks, only a fraction of it (8.7 per cent) Rs 55,000 crore falls under the MSME category.

As per the latest RBI data, roughly 5 per cent of the total loans given by commercial banks to MSMEs were classified as NPA by March 2014 end.

This rose to 6.32 per cent in March 2015 and 8.32 per cent of the total loans given to this sector had turned into NPAs by the end of March 2016, which is still less compared to the overall book size of bad loans.

The Real Picture

Talking about why the MSME sector is being seen as a category with high volume of willful defaults, Sankar Chakraborti, CEO, SMERA Rating Ltd. says, "This is not the case, MSME category has been one of the lowest contributors to bank NPAs. There are also lower slippages as compared to larger loans. Additionally, loans are backed by collaterals so risk is substantially lower for lenders. With 90 per cent of all industry classified under this category, MSMEs are of systemic importance. Due to forward linkages, the situation prevalent in larger entities is putting pressure on MSME liquidity management. Stress in the sector can also be attributed to the effects of demonetization on the larger economy. Due to their smaller size, MSMEs are rated lower and generally carry a higher risk weight. Therefore, even the lending rate is higher for this category by at least 200-300 bps as compared to larger entities."

Thus, for banks to consider MSMEs as a category with high NPAs will be wrong. The propensity for an SME to become a willful defaulter is also lower, as a lot for them is at stake. Banks should understand and take it to cognizance that the problems MSMEs face is poor cash flows because the market is highly fragmented and more vulnerable to market shocks with highly unstable revenues.

Typically, they have limited credit history and so it becomes difficult to have easy credit availability. Also, there are close to 50-55 schemes that the government is running to improve credit at lower rates to SMEs but banks largely remain ignorant of them.

Hence, the implementation of such policies become a problem. H P Kumar, Former CMD, NSIC and Advisor, Power2SME, says, "According to the RBI figures, 86.4 per cent of NPAs with banks are from large corporate, so only the remaining 15-16 per cent have to be from SMEs. Under special schemes, the government provides 80 per cent credit guarantee of the principal amount up to a maximum of Rs 2 crore on loans to SMEs. But MSMEs largely have a trust deficit so these schemes are not successful."

Achin Nirwani, AGM, MSME Vertical, Care Ratings, opines, "When we talk about the figure of Rs 55,000 crore of NPA with banks in the MSME sector, the overall growth of NPAs with the banks comes out to be a small proportion. Unlike corporates, MSMEs are not very professional with credit structuring and refinancing of its debt. Bigger corporate can have multiple companies under it, but for MSMEs, it is bread and butter for them. Let us take the example of crisis at Maruti Udyog Ltd. plant at Manesar, Gurgaon. So, Maruti did not default on its loans but because the business of MSMEs is dependent on Maruti and the factories were shut for 92 days, these smaller companies had a liquidity crisis. So it is not that they had defaulted. Banks turned their loans as NPAs but later on, they were able to recover everything that is after 90 days."

Possible Solution

To tackle the menace of burdening NPAs in banks, the Union government has recently passed an ordinance wherein the executive has been given the power to instigate RBI to initiate the NPA resolution process once a default has been established, something that was the sole right of the central bank so far.

While this may be seen as the executive's overreach into the domain of RBI's independence, the ordinance has provided for a linkage of the Bankruptcy Code and the Banking Regulation Act which was not there before and could have come in the way of the RBI taking action against a bank for ignoring a default.

This however, does not seem to have the capacity to deliver a far reaching reformation on the problems faced by MSMEs on loans and defaults. In fact, the ordinance will empower banks to initiate recovery mechanism without an overwhelming consensus from the bank's boards which may expose MSMEs to further uncertainties and a possible loss of their business.

Talking about how the ordinance will affect the MSME sector and what is needed, VK Agarwal, Managing Director and CEO, Shashi Cables Limited, says, "This ordinance could further aggravate the problems for MSMEs. Banks are already not keen on forming rehabilitation plans for MSMEs, they want to sell off the assets to recover the loans. The procedure to declare a borrower as a willful defaulter is also discretionary and the format of 90 days delay to declare an unpaid loan as an NPA adds to the vicious circle for MSMEs who are unable to avail any financial help from banks to resuscitate themselves and to be able to pay off the loan. The government should form a separate comprehensive plan for us. Defaults should be analysed case by case and a rehabilitation plan should be offered to the sick units to get them back on track."

The fact that the government has tried to expedite the process of recovery by promulgating an ordinance and not a usual passing of the law in the parliament speaks of its urgency to showcase the recovery of the banking sector's health.

This strategy may come down heavily on MSMEs who cannot protect themselves through litigation like big corporates.

To allay the fears of MSMEs while also commenting on the impact of the ordinance on bank's NPAs, B. Srinivasan, Dy. General Manager and Business Head - SME, SBI, says, "There will obviously be a cascading effect of the ordinance on MSMEs but the sector will not be at a disadvantage. The implementation of the rules will reduce the NPAs with banks and improve their books. Since even the board of the banks cannot overrule the directives, this will lead to better performance of the bank's assets."

To this, Ranjith Nair, Chief Manager, Business Banking and SME, IDFC Bank Ltd., adds, "The ordinance is actually aimed at big businesses that have large NPAs with banks. Also, a strict framework of rules will create fear among the class of willful defaulters who were misusing the existing rules to their own benefit. By structure, MSMEs mostly do not try to default willfully. Thus, MSMEs necessarily should not be at a disadvantage over the promulgation of the ordinance on NPAs with banks."

While the government's move on the outset may not appear to be in favour of the MSME sector, Chakraborti opines, "Bankers have to evolve a new methodology to identify the right MSMEs to lend to. The high potential MSMEs must be segregated and incubated. The evolution of the sector is important at this time, given the fact that it is the very backbone of our economy."

It is also the Government and RBI's role to make the MSME sector an attractive segment for disbursement since there is a lot riding on its performance, from both the employment as well as economic growth's perspective. If the policy formulation could be directed in a progressive manner, a change could actually mean an improvement.

With the credit issue for MSMEs improving over time, the country could see a remarkable overall growth in a very short period of time. Since after the ordinance, a formal passing of law is awaited in the parliament, the government should improve the provisions in the draft law.

(This article was first published in the June issue of Entrepreneur Magazine. To subscribe, click here)