Conjuncted: Non-Performing Assets and Indian Banking – Unfolding Crisis

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The banking crisis is indeed getting ‘Alarming’ now. With Credit Suisse citing the NPAs as 8.4 per cent of the GDP and the latest figures toppling the country from its so-called vantage position of fastest growing major economy and bracketing the GDP growth at 6.1 per cent, we are actually faced with a negative growth considering banking sector in the country as the vanguard of India’s economic prowess. The ratio of NPAs to GDP measures the potential losses in relation to the size of the economy. This is especially useful in cross-country comparisons, given that countries are at different levels of GDP. The problem with this measure is that it does not indicate whether banks are able to handle the NPAs with their own resources or their own capital opening up possibilities for either capital infusion, which the Government would have to raise exponentially, or raising funds from the capital market. A more commonly used metric is the NPA to loans ratio. This shows the fraction of bank loans that has turned bad. One shortcoming of this measure is that it suggests the problem can be solved through denominator management – growing the loan books of banks to make the NPA ratio smaller. This growing out of the problem approach is not a reliable one. It depends on the overall economic environment and on the demand for credit. It assumes that the source of the NPA problem is external to the banking system and not in the weaknesses of the lending processes. If the demand for credit is slow it becomes difficult for the banks to grow their loan books. Even if the demand for credit were high, it would be difficult for the NPA-ridden banks to grow. Prolonged NPA episodes erode banks‘ capital and constrain their ability to grow their loan books. 

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