Received: 18 July 2017 Accepted: 24 July 2017

DOI: 10.1002/pa.1672

PRACTITIONER PAPER

Lessons from NPAs crisis in Indian banks

Ganesh Kumar Nidugala | Abhay Pant

Department of Economics, Indian Institute of

Management Indore, Indore, India Nonperforming assets (NPAs) crisis in Indian public sector banks is one of the biggest challenges
Correspondence before the current government in 2017. The finance ministry, Government of India, and the cen-
Ganesh Kumar Nidugala, Department of tral bank, the Reserve Bank of India, are worried about the surging NPAs in Indian public sector
Economics, Indian Institute of Management
banks because of their huge macroeconomic impact and systemic risk to the financial system. If
Indore, Prabandh Shikhar, Rau‐Pithampur
Road, Indore, Madhya Pradesh 453556, India. not paid timely attention, it can hamper the economic and financial stability of the nation. Rising
Email: ganesh@iimidr.ac.in NPAs in Indian public sector banks are a result of bank specific, macroeconomic, and political fac-
tors. In order to control the surging NPAs in Indian public sector banks, the government and the
Reserve Bank of India have implemented new crisis management framework which however is
not immune to several challenges. This paper looks at NPAs crisis from the lens of crisis manage-
ment, stakeholder0 s engagement, government relations, and issue management. Harris and
Fleisher (2016) identify crisis management, stakeholder engagement, government relations, and
issues management as important organizational activities that constitute part of public affairs.
This paper follows a tripartite structure where it first investigates the causes of NPAs in Indian
public sector banks. Second, it examines the crisis management framework developed by the pol-
icy makers and highlights the key challenges. Third, in light of these challenges, it makes recom-
mendations to tackle the NPAs crisis in Indian public sector banks.

1 | I N T RO D U CT I O N 11.2% growth rate in the period a year ago.4 Falling credit growth in
banking sector has affected the economic growth of the nation. The
In the line with international best practices, nonperforming assets gross NPAs5 of public sector banks6 have surged by 56.4% (to Rs.
(NPAs) are those assets which fail to yield any income for the bank. 6.14 trillion) for the 12‐month period ended December 2016.7 Indian
The surging NPAs in Indian banking sector has posed a serious threat banking system (public‐owned plus private‐owned banks) is crippled
to the financial stability of the nation. The rising bad loans in public with the NPAs of around Rs. 8 trillion out of which public sector banks
sector banks have paralyzed their performance leading to huge losses account for more than 75%.8 Public sector banks are in a mess as their
0 1
for these banks. According to Arvind Panagriya, Niti Aayog s vice capital adequacy is under strain, return on assets and return on equity
chairman, rising NPAs is a gigantic problem and the biggest challenge are negative, and more than quarter of loan given by these banks to
before the current government.2 Arvind Subramanium, chief economic
adviser to the government called India0 s NPAs problem as the no. 1
4
http://www.business‐standard.com/article/economy‐policy/bank‐credit‐
macroeconomic challenge for the Indian economy.3 Bad loans crisis
growth‐falls‐to‐4‐8‐117030400009_1.html, accessed July 11, 2017.
has stagnated the growth and performance of the banking sector with 5
Gross NPAs are given as the sum of all loan assets recognized as NPAs under
large number of public sector banks experiencing losses. The credit RBI regulations or guidelines. As per RBI, Net NPAs = Gross NPA − (Balance in
growth in Indian banking sector is continuously falling and has regis- Interest Suspense account + DICGC/ECGC claims received and held pending
tered a growth rate of 4.8% as on February 17, 2017 as against adjustment + Part payment received and kept in suspense account + Total pro-
visions held). The well‐known practice is to use the ratio of gross NPAs to gross
advances and net NPAs to net advances.
1
Niti Ayog is India0 s official policy think tank which replaced the erstwhile plan- 6
Public sector banks are state‐owned banks where majority of ownership (at
ning commission. least 51% of equity) is by the government of India.
2 7
http://indianexpress.com/article/business/banking‐and‐finance/npa‐chal- http://indianexpress.com/article/business/banking‐and‐finance/bad‐loan‐cri-
lenge‐the‐biggest‐before‐centre‐arvind‐panagariya/, accessed June 23, 2017. sis‐continues‐56‐4‐per‐cent‐rise‐in‐npas‐of‐banks‐rbi‐4533685/, accessed July
3
NPA issue is India0 s No.1 macroeconomic challenge: Arvind Subramanian,” 09, 2017.
8
Money Control, March 29, 2017, http://www.moneycontrol.com/news/busi- http://www.firstpost.com/business/employees‐of‐national‐banks‐threatens‐
ness/economy/npa‐issue‐is‐indias‐no‐1‐macroeconomic‐challenge‐arvind‐ strike‐on‐22‐august‐over‐mergers‐non‐performing‐assets‐3762797.html,
subramanian‐2248985.html, accessed April 02, 2017. accessed July 09, 2017.

J Public Affairs. 2017;17:e1672. wileyonlinelibrary.com/journal/pa Copyright © 2017 John Wiley & Sons, Ltd. 1 of 6
https://doi.org/10.1002/pa.1672
2 of 6 NIDUGALA AND PANT

industry are under stress.9 According to Reserve Bank of India (RBI), banks. Private domestic banks are those banks where majority of
financial stability report of June 2017 gross NPAs of all scheduled shareholding is by private domestic shareholders. In case of foreign
commercial banks have increased from 9.2% in September 2016 to banks majority of shareholding is by foreign investors (Ahamed &
9.6% in March 2017.10 Pankaj Patel, President of Federation of Indian Mallick, 2017). Public banks have a share of 73.7% in the assets of
Chambers of Commerce and Industry, remarks that the early resolution the banking sector whereas private and foreign banks have a share
of NPAs crisis is important for making the banking sector more robust of 19.5% and 6.7%, respectively (Ahamed, 2017). The RBI is the ulti-
and may facilitate credit takeoff and lead to greater economic expan- mate monetary authority that regulates the banking sector and was
sion.11 According to the RBI, gross NPAs of banks may rise further established in 1935 under the RBI Act, 1934.
from 9.6% in March 2017 to 10.2% in March 2018, and under severe
macro test scenario,12 six banks will see fall in their capital to risk
assets ratio below statutory provision of 9%. It also points out that if
3 | DETERMINANTS OF THE NPAS IN
NPAs surge to 11% against the projection of 10.2% the entire banking
INDIAN PUBLIC SECTOR BANKS
sector profits would be wiped out for FY 2018.13 N. S. Vishwanathan,
deputy governor RBI, argues that the restoration of banking sector
According to Raghuram Rajan, ex‐governor of RBI, high NPAs in Indian
health is very important as nonbanking finance companies, mutual
commercial banks are a result of various factors such as economic
funds, and capital markets cannot fully substitute for banks in a
slowdown in domestic and global economy, statutory and other delays
bank‐based system like that in India.14 Hence, if not addressed ade-
in approval of projects under implementation, aggressive lending by
quately and timely, NPAs crisis faced by Indian banks may paralyze
banks in periods of economic boom and upturn, laxity in credit risk
the banking system adversely affecting its economic and financial sta-
appraisal and improper loan monitoring by banks, lack of appraising
bility. Against this backdrop, the crisis management framework imple-
skills for specialized projects, willful defaults, loan frauds, and corrup-
mented by government and RBI is a good measure in preventing the
tion.15 The accumulated NPAs in banks are a result of delays in imple-
festering of NPAs crisis, but it is not immune to certain challenges.
mentation and execution of projects, loss of raw materials, soaring real
After highlighting the structure of Indian banking sector in the next
interest rates, and dumping by the trading partners, gold plating of pro-
section, this paper investigates the determinants of surging NPAs in
jects, inappropriate planning, and poor execution.16 According to ex‐
Indian public sector banks, examines the crisis management framework
deputy governor of RBI, K. C. Chakrabarty, high NPAs in banks are a
implemented by Government of India and RBI, highlighting its dynam-
result of nonperforming administration and everybody is responsible
ics and the key challenges ahead, and makes several important recom-
for it.17 An important reason for high stressed assets in banks is that
mendations to tackle the NPAs crisis in the public sector banks.
the practice or procedure of better recognition of NPAs is being
followed as these were swept under the carpet as restructured
advances or assets in the past.18 Indian banks have been resorting to
2 | S T R U C T U R E OF TH E I N D I A N B A N K I N G
large amount of restructuring of NPAs which gives them a leeway to
SYSTEM
maintain lower provisions. The major Asset Quality Review by RBI in
2015 revealed the true picture of rising NPAs in banks as incorporation
Indian banking system consists of commercial banks and the coopera-
of restructured standard advances (RSA) gave a more holistic view of
tive banks with commercial banks having market share of over 95% at
total stressed assets19 in banks. Practice of restructuring of standard
the end of March 2012 (Sarkar & Sarkar, 2016). Together, the commer-
advances creates moral hazard problem and gives leeway to borrowers
cial and cooperative banks are referred to as scheduled commercial
to state that projects have failed due to extraneous events. The official
banks as they are part of second schedule of RBI Act, 1934 (Ahamed,
NPAs figures (gross NPAs to gross advances) undermines the high loan
2017). Scheduled commercial banks can be further classified into pub-
delinquencies in banks (Samantaraya, 2016). Total stressed assets in
lic sector banks, private sector banks, foreign banks, and regional rural
Indian banks have gone up from 10% in March 2014 to 11.5% in
9
http://www.livemint.com/Opinion/3apxaOdL0dSNLLXWMHI5lO/NPA‐reso- March 2016.20 Though the stressed advances declined from 12.3% in
lution‐a‐rough‐road‐ahead.html, accessed July 09, 2017
10
http://economictimes.indiatimes.com/industry/banking/finance/banking/
15
banks‐or‐india‐inc‐who‐will‐come‐back‐from‐the‐brink‐first/articleshow/ http://www.dnaindia.com/money/report‐six‐reasons‐why‐bad‐loans‐are‐a‐
59404105.cms, accessed July 09, 2017. menace‐in‐india‐according‐to‐raghuram‐rajan‐2207976, accessed July 09,
11
2017.
http://economictimes.indiatimes.com/industry/banking/finance/banking/
16
banks‐or‐india‐inc‐who‐will‐come‐back‐from‐the‐brink‐first/articleshow/ http://economictimes.indiatimes.com/markets/stocks/news/here‐are‐9‐
59404105.cms, accessed July 09, 2017. ways‐for‐banks‐to‐raise‐capital‐to‐tackle‐npas/articleshow/59518760.cms,
12
accessed July 10, 2017.
Macro stress testing investigates the impact of macroeconomic shocks on
17
asset quality and CRAR in banks. It is conducted to check for the resilience of http://www.livemint.com/Politics/7IGOOzFPIwkBG2zu0pAo2L/If‐NPAs‐are‐
the banking sector for stress events or macroeconomic shocks. high‐everybody‐is‐responsible‐KC‐Chakrabarty.html, accessed July 10, 2017.
18
13
http://timesofindia.indiatimes.com/business/india‐business/bank‐npas‐to‐ http://www.financialexpress.com/opinion/growth‐and‐asset‐failure/626132/,
cross‐10‐2‐in‐fy18‐says‐rbi‐report/articleshow/59393770.cms, accessed July accessed July 10, 2017.
19
09, 2017. Total stressed assets are calculated as the ratio of gross NPAs plus
14
http://www.thehindubusinessline.com/money‐and‐banking/rbi‐warns‐of‐ restructured standard advances to gross advances.
20
more‐npa‐pain‐sees‐bad‐loans‐topping‐10‐by‐march/article9743632.ece, http://www.thehindu.com/business/Economy/Bank‐NPAs‐may‐hit‐8.5‐by‐
accessed July 09, 2017. March/article14406693.ece, accessed July 10, 2017.
NIDUGALA AND PANT 3 of 6

September 2016 to 12% in March 2017,21 it is still higher than the fig- mechanism in public sector banks is reflected in the NPAs difference
ure for March 2016. According to Renny Thomas, senior partner between public and private banks.28 In long‐term governance issues
McKinsey and Company, stressed assets in the Indian banking sector in public sector banks need to be addressed to prevent any festering
are currently more than their net worth posing a serious threat to of asset quality crisis.29
the entire equity base of banks.22 Apart from the downturn in the
global economy and falling commodity prices, bureaucratic red tape,
delays in land acquisitions, and politically inspired agitations have 4 | C R I S I S M A N A G E M E N T —R E S P O N S E S T O
played a crucial role in influencing surging bad loans in Indian banks. 23 T H E CR I S I S A N D C H A L LE N G E S A H E A D
As per a press article, priority sector lending by public sector banks is
Harris and Fleisher (2016) identify crisis management, stakeholder
just a part of the problem and high NPAs in these banks are a result
24 engagement or management, government relations, and issues manage-
of inefficiencies in credit and recovery mechanisms. RBI deputy gov-
ment as important organizational activities that constitute part of public
ernor Viral Acharya attributes burgeoning NPAs in public sector banks
affairs. We identified these factors at play in this case. Indian govern-
to their lending at nonoptimal conditions to nonviable private projects,
ment and RBI implemented a crisis management framework to reduce
welfare schemes, etc.25 The theoretical foundations of agency theory
the high NPAs in Indian commercial banks in particular the public sector
(Jensen & Meckling, 1976) deals with the famous principal agent
banks. Under this framework in May 2017, the Indian government
problem where the divergence between the interest of owners and
cabinet passed the Banking Regulation Amendment Ordinance, 2017
managers may give rise to managerial opportunism and agency con-
to solve the rising stressed assets problem and to prevent the festering
flicts. Ownership and board characteristics may play a crucial role in
of the asset quality crisis. The ordinance amends section 35A of the
influencing surging NPAs in Indian banks. In the Indian banking sector
Banking Regulation Act 1949 and gives additional powers to RBI to
ownership seems to play a crucial role in explaining NPAs since NPAs
direct banks to initiate insolvency proceedings against bad loans.30 On
figures are significantly higher in public sector banks when compared
the basis of the advice of its internal advisory committee,31 RBI has
to private sector banks. Samantaraya (2016) examined the determi-
identified 12 big accounts of corporate borrowers for immediate resolu-
nants of stressed assets in Indian commercial banks from 2003–2004
tion under Insolvency and Bankruptcy Code (IBC) 2016. These accounts
to 2013–2014 and found past credit growth, GDP, priority sector
amount to almost 25% of the current gross NPAs of the Indian banking
advances, capital adequacy ratio, and return on assets as significant
sector system. Their total NPAs stand at around Rs. 1.75 trillion.32
determinants of NPAs in Indian banks. Public sector banks had higher
Government relations and lobbying occupy a very prominent position
stressed assets as compared to private banks. In India, particularly
in the domain of public affairs. These figures also highlight the dynamics
the public sector banks are suffering problems relating to high NPAs,
of government relations and lobbying with respect to corporate bor-
higher provisions, and sluggish credit growth.26 Chaudhuri and
rowers. Some of the public sector banks, controlled by politicians and
Sensarma (2008) conducted a study on bank NPAs in India and found
bureaucrats, are forced to lend to large corporate borrowers. Corporate
that establishment of debt recovery tribunals reduced the incidence of
borrowers with good government relations get large disbursement of
NPAs. Also, economic growth, size, ownership, profitability, and rural
loan. The boards of public sector banks have nominated members of
urban aspects of operation were related to bank NPAs. Dhar and
Government of India. The lobbying by large corporate group influences
Bakshi (2015) investigated the factors which explained bank NPAs in
the lending decisions of public sector banks. Hence, often ignored polit-
India and found bank lending to sensitive sectors, capital adequacy
ical factor is one of the major determinants of rising NPAs in public
ratio, and net interest margin as important determinants of bank NPAs
sector banks. The politicians and bureaucrats force banks to put good
in India. Galloping bad loans are a big problem for Indian banks due to
money after bad in case of fraudulent borrowers.33 Accumulation of
higher provisions, higher slippages, and lower profits or earnings.27
NPAs in public sector banks is also a result of politically induced lending
According to ex‐governor of RBI, Y. V. Reddy, weak governance
in these banks.34 For example, Sudhir Kumar Jain ex C. M. D. of public
21
https://rbidocs.rbi.org.in/rdocs/PublicationReport/Pdfs/0FSR_
28
30061794092D8D036447928A4B45880863B33E.PDF, accessed July 10, https://www.bloombergquint.com/markets/2017/07/10/why‐nse‐took‐
2017. three‐hours‐four‐attempts‐to‐resume‐trading‐after‐software‐glitch accessed
22
http://www.thehindubusinessline.com/money‐and‐banking/stressed‐assets‐ July 10, 2017.
29
of‐indian‐banks‐exceed‐their‐networth‐says‐mckinsey‐report/article9705952. http://premium.thehindubusinessline.com/portfolio/macro‐view/is‐the‐npa‐
ece, accessed July 10, 2017. crisis‐set‐to‐worsen/article8663413.ece, accessed July 10, 2017.
23 30
http://www.thehindubusinessline.com/opinion/npas‐banks‐alone‐are‐not‐to‐ http://economictimes.indiatimes.com/news/economy/policy/framework‐
blame/article8955877.ece, accessed July 10, 2017. under‐npa‐ordinance‐by‐rbi‐may‐be‐out‐within‐15‐days/articleshow/
24
http://www.business‐standard.com/article/opinion/charan‐singh‐why‐are‐ 58788611.cms, accessed July 10, 2017.
npas‐higher‐in‐public‐sector‐banks‐114051901183_1.html, accessed July 10, 31
The internal advisory committee mainly comprises of RBI0 s independent board
2017. members.
25 32
http://www.zeebiz.com/india/news‐deputy‐rbi‐governor‐viral‐acharya‐modi‐ http://indianexpress.com/article/business/banking‐and‐finance/rbi‐iden-
brings‐back‐focus‐on‐banks‐npa‐issue‐9831, accessed July 10, 2017. tifies‐12‐mega‐defaulters‐for‐insolvency‐reserve‐bank‐of‐india‐4702973/,
26
http://www.zeebiz.com/india/news‐deputy‐rbi‐governor‐viral‐acharya‐modi‐ accessed July 10, 2017.
33
brings‐back‐focus‐on‐banks‐npa‐issue‐9831, accessed July 10, 2017. http://www.thehindu.com/biz/2003/09/08/stories/2003090800060200.
27
http://www.businesstoday.in/sectors/banks/cabinet‐chooses‐ordinance‐to‐ htm, accessed July 10, 2017.
34
resolve‐banks‐npas‐problem‐but‐are‐there‐other‐options/story/251439.html, http://www.business‐standard.com/article/opinion/governance‐pain‐of‐pub-
accessed July 10, 2017. lic‐banks‐115022300002_1.html, accessed July 10, 2017.
4 of 6 NIDUGALA AND PANT

sector Syndicate Bank was arrested for taking bribes from companies 3 framework. Public sector banks need higher capitalization for meet-
for sanctioning and disbursement of loans in 2014.35 It is also worth- ing Basel 3 capital requirements, better provisioning of high NPAs and
while to mention that the case also highlights the dynamics of improving its business.39 The crisis management framework for NPAs
stakeholder0 s engagement. NPAs issue is like a festering wound on the crisis resolution gives more powers to RBI to mandate banks to initiate
banking body of the Indian economy. The relevant stakeholders here insolvency proceedings against large corporate borrowers but does not
are finance ministry, RBI, bank managers, financial institutions, deposi- solve the problem of huge bank capital requirements. The capital
tors, etc. NPA crisis has called for immediate attention from relevant crunch in public sector banks can be viewed from the perspective of
stakeholders where regulator RBI and finance ministry have joined issue management40 which involves identification, management, and
hands to tackle the issue in a systematic manner by initiating the insol- resolution of issues. In this case, the issue identified is the surging
vency proceedings against large corporate borrowers accounting for stressed assets in public sector banks and their severe capital crunch.
substantial portion of banking sector NPAs. The passing of NPA ordi- Issue analysis focuses on the past experience with the issue, dealing
nance by cabinet and referring of large accounts to National Company with the issue, and identifying its impact of the issue. Capital crunch
Law Tribunal highlights the dynamics of relevant stakeholder0 s engage- in public sector banks in past was taken care through recapitalization
ment in the NPAs issue management. Given the crucial importance of by the government which increased the fiscal burden of the govern-
banking sector stability relevant stakeholders have come up to tackle ment. If the issue is not contained, it may culminate into a severe crisis
the biggest macroeconomic challenge of rising NPAs. RBI has placed resulting into failure of public sector banks and may hamper economic
prompt corrective action on IDBI Bank, Dena Bank, UCO Bank, Central and financial stability of the nation. Issue resolution and action plan
Bank of India, etc., on account of their rising NPAs (NPAs over 6%) and would require a dynamic strategy where the government and the RBI
negative return on assets. Under prompt corrective action framework, play a proactive role in containing the issue. In this case, the most
there are restrictions placed on banks expansions, exposures, and divi- suited action plan for revitalizing public sector banks could be to raise
36
dend payouts. In the extreme cases, mergers are also a possibility. capital from the market or by selling their noncore assets. According to
As per Finance Minister Arun Jaitely, Government of India is actively RBI, banks may require capital infusion of Rs. 0.48 trillion in the current
working for consolidation of banks.37 Apart from the crisis management financial year 2017–2018 and government is likely to infuse more
framework this case clearly depicts attributes of stakeholder0 s engage- money in public sector banks.41 However, recapitalization by the gov-
ment for NPAs issue to prevent any extreme banking crisis. ernment is a temporary solution and may only worsen the fiscal deficit
of the government. The capital allocation by the government may not
be sufficient to address the capital needs of the public sector banks. In
4.1 | Challenges ahead
the words of K. C. Chakrabarty, ex‐deputy governor of RBI, nothing
The current crisis management framework under the supervision of has changed with the implementation of the IBC and the stressed
Government of India and the RBI is not free from certain limitations. assets in banking sector would be as high as Rs. 20 trillion.42 According
According to Moody0 s credit rating agency, NPA ordinance may to Moody0 s investor service, the IBC will have limited effectiveness
improve the efficacy of NPAs resolution but it does not address the because even the control of the firm may shift from management to
problem of lack of capital at public sector banks which has prevented insolvency professionals, management may still play a role in day to
them from effectively writing off their bad loans.38 Besides, writing day operations of the firm.43 The ordinance measure is hardly going
off loans to large private corporate borrowers is a politically sensitive to solve the problem of stressed assets in public sector banks, and
issue in India as it is perceived to be crony capitalism. Management what is really needed is the privatization of weak public sector banks
of public sector banks is loath to this idea because they may be and prudent and political interference‐free loan origination. Otherwise,
perceived to be corrupt and complicit in crime committed by perceived problem of NPAs could surface again even if it is resolved now.
crony capitalists. The incumbent government will also find this politi- As highlighted by finance minister Arun Jaitely, government is
cally difficult to handle. This is possibly one of the reasons why the exploring the option of consolidation among public sector banks. In
resolution of NPAs was pushed to the RBI which is an independent, fact government has recently completed the merger of five State Bank
nonpartisan, professional body. Public sector banks with high NPAs of India associates and Bharatiya Mahila Bank with the State Bank of
are facing capital crunch. Due to high NPAs, these banks may require India. In the words of RBI deputy governor S. S. Mundra, merger for
to make large provisions increasing their capital needs. Moreover,
given the provisioning requirements for high NPAs, it may be difficult
39
for these banks to maintain higher capital requirements under Basel http://zeenews.india.com/business/news/finance/psu‐banks‐need‐higher‐
capitalisation‐for‐dealing‐with‐npas_130711.html, accessed July 10, 2017.
35 40
Ibid. Issues management is an important dimension of public affairs.
36 41
http://www.moneycontrol.com/news/business/economy/now‐central‐bank‐ http://economictimes.indiatimes.com/news/economy/finance/government‐
of‐india‐comes‐under‐rbis‐prompt‐corrective‐action‐2304101.html, accessed likely‐to‐pump‐more‐money‐into‐psu‐banks/articleshow/59481356.cms,
July 10, 2017. accessed July 10, 2017.
37 42
http://www.business‐standard.com/article/finance/govt‐actively‐working‐ http://www.moneycontrol.com/news/business/economy/npa‐resolution‐to‐
towards‐bank‐consolidation‐arun‐jaitley‐117061200507_1.html, accessed July be‐a‐long‐road‐for‐banks‐shows‐essar‐move‐2320307.html, accessed July 10,
10, 2017. 2017.
38 43
http://www.firstpost.com/business/npa‐ordinance‐letting‐rbi‐fight‐npa‐bat- http://www.moneycontrol.com/news/business/economy/npa‐resolution‐to‐
tle‐is‐no‐solution‐privatise‐weak‐psbs‐before‐time‐runs‐out‐3435108.html, be‐a‐long‐road‐for‐banks‐shows‐essar‐move‐2320307.html, accessed July
accessed July 10, 2017. 10,2017.
NIDUGALA AND PANT 5 of 6

the sake of merging a weak bank with a strong bank may make the private banks have performed reasonably better in terms of bad loans
strong bank a weak bank. It should be undertaken strategically and problem.
should result into geographical integration.44 As per Ashwani Rana, Total stressed assets give a more realistic picture of high loan
vice president of National Organization of Bank Workers, merger is delinquencies in banks as it incorporates restructured standard
not a solution for banking problems and does not provide guarantee advances. The official NPAs figures undermine the true problem of
that NPAs problem in public sector banks will be completely surging bad loans in Indian banks. Restructuring of assets is one of
resolved.45 Even Raghuram Rajan, ex‐governor of RBI, highlighted that the critical factors for galloping NPAs in Indian banks.
consolidation of banks may adversely affect the balance sheet of Corporate governance mechanism is an important factor that
strong banks and there may be several most merger issues such as influences stressed assets in the banking sector and needs a radical
the human resources management issues.46 reform.
The RBI is being burdened with resolution of NPAs through the
IBC. This is an additional role for RBI, and it may not be sufficiently
equipped to handle this role. When the companies are forced into
6 | RECOMMENDATIONS
insolvency by the lenders, there should be buyers who are willing to
take on the debt burden of the companies. Because of lack of interest
First, in order to effectively tackle the NPAs, the crisis management
among domestic players, if lenders look for foreign buyers, it could cre-
framework should include the privatization of weak public sector
ate political stir and government may be accused of selling assets to
banks. It will take away government control and reduce any kind of
foreign‐owned companies. The legal hoops also raise questions about
political interference. This move may invite agitation from unions and
the efficacy of NPAs resolution under IBC. Essar Steel, one of the com-
opposition parties besides government may find it difficult to fulfill
panies identified for insolvency proceedings, has moved to the court
its socio development objectives such as financial inclusion. Govern-
and challenged RBI0 s directives to banks for initiating insolvency
ment would also not be willing to lose its control over these banks. Pri-
proceedings against the company. Lawyers and bankers are also
vatization would be a major reform for public sector banks and would
expecting other companies referred under IBC to move to court which
take care of political issues.
may hamper and impede the NPAs resolution process. Though the
Second, another important challenge that needs to be effectively
implementation of bankruptcy code has made bankers and lawyers
addressed is the capital shortage in public sector banks. Apart from
optimistic, there are certain infrastructure challenges such as number
recapitalizing banks which may constrain the fiscal burden of the gov-
of insolvency professionals, expertise of these professionals, delays
ernment, finance ministry, and the regulator could explore options
by borrowers, 9‐month deadline constraint, and capital challenges
such as raising money from the market through follow on public offers.
due to high provision requirement in banks.47 The measures such as
Other possible options include selling their noncore assets or loan
establishment of debt recovery tribunals and securitization act have
portfolios, issuing of deep discount rights, etc.
failed in the past due to infrastructure challenges and legal problems.
Third, effective stakeholder0 s engagement is critical in issues and
crisis management. The government and the RBI should continue
working together to curtail rising stressed assets in public sector banks.
5 | C O N CL U S I O N —L E S S O N S FR O M N P A S Any kind of crisis management framework or any further policy mea-
CRISIS IN PUBLIC SECTOR BANKS sures should involve effective coordination and engagement from
RBI, government, and external experts. Privatization will also need
Given the political setup and dynamics of Indian banking sector, it is involvement of workers union.
not easy to address the NPAs problem in public sector banks. Bank Fourth, weak governance mechanism in public sector banks is one
NPAs in India are due to complex mix of bank specific, macroeconomic, of the important reasons for galloping bad loans in these banks. As
and political factors. highlighted by ex‐governor of RBI, Y. V. Reddy, weak governance
Ownership plays an important role in explaining high NPAs in mechanism may play a crucial role in influencing bank NPAs. We
Indian banks. Public sector banks are additionally regulated and have recommend reforms in governance mechanisms in public sector banks
to fulfill the socio development objectives of the government. High such as separation of CEO and Chairman position, more independent
NPAs are a serious problem in public sector banks, whereas board members, greater diversity and selection criteria of board mem-
bers in these banks, etc. The establishment of Banks Board Bureau
(BBB) in April 2016 for governance reforms in public sector banks
44
http://zeenews.india.com/business/news/finance/merger‐of‐banks‐has‐to‐ was a step in this direction. But its effectiveness has come into ques-
be‐very‐focused‐mundra_1834378.html, accessed July 10, 2017. tion in recent times. A popular press article quotes that the finance
45
http://www.firstpost.com/business/employees‐of‐national‐banks‐threatens‐ ministry de novo scrutinizes on the matters of appointment related
strike‐on‐22‐august‐over‐mergers‐non‐performing‐assets‐3762797.html,
to heads of public sector banks instead of seriously taking suggestions
accessed July 10, 2017.
46 of BBB and referring it to cabinet for approval.48 According to D.K.
http://archive.indianexpress.com/news/rbi‐governor‐raghuram‐rajan‐cau-
tions‐against‐merger‐of‐unhealthy‐banks/1279126/,accessed July 10, 2017.
47 48
http://www.moneycontrol.com/news/business/economy/npa‐resolution‐to‐ http://www.moneycontrol.com/news/business/economy/npa‐resolution‐to‐
be‐a‐long‐road‐for‐banks‐shows‐essar‐move‐2320307.html, accessed July 10, be‐a‐long‐road‐for‐banks‐shows‐essar‐move‐2320307.html, accessed July 10,
2017. 2017.
6 of 6 NIDUGALA AND PANT

Mittal, former secretary department of financial services, the present Sarkar, J., & Sarkar, S. (2016). Bank ownership, Board Characteristics and
structure of BBB is not workable. 49
BBB has made several recommen- Performance: Evidence from Commercial Banks in India. Indira Gandhi
Institute of Development Research, Mumbai.
dations to the government regarding governance and other standards
in public sector banks but they are under dust as government is not
Ganesh Kumar Nidugala is a professor at
interested in revamping the banks.50
IIM Indore. He was awarded with Ford
Fifth, a suggestion currently overlooked is the establishment of
Foundation Post‐Doctoral Fellowship in
bad bank to contain stressed assets in public sector banks. Advocated
Economics (1996–1997) under which he
by RBI deputy governor, Viral Acharya, it holds good promise to reduce
pursued research and course work at
NPAs by focusing on recovery of loans. However, for its effectiveness,
University of Southern California, Los
it is imperative to reduce government stake in it.
Angeles, USA. His work experience
Sixth, an important reason for high stressed assets in public sec-
includes teaching at T.A.Pai Management
tor banks is the large amount of restructuring of bad assets. Banks
Institute, Manipal; Stansfield School of
should not take restructuring as a process to hide NPAs under the
Business, Singapore; and IIM Indore. He has presented several
carpet. Because RSA are a kind of problem loans, the RBI should
papers and cases in Indian and International conferences, he has
increase the provisioning requirements of RSA and ensure proper
published cases in Richard Ivey and ET Case Center, and his papers
strict identification of NPAs by banks. It is important for the
have been published/accepted for publication in Journal of Public
government to ensure that the capital needs of public sector banks
Affairs, International Journal of Technology Management and Sus-
are met.
tainable Development, Journal of Emerging Market Finance, Economic
and Political Weekly, The Indian Economic Journal, Indian Economic
ORCID
Panorama, Indore Management Journal, etc. His areas of interest
Ganesh Kumar Nidugala http://orcid.org/0000-0002-6063-449X
are Macroeconomics, Economic growth and development, and
Abhay Pant http://orcid.org/0000-0003-1846-1676
International finance.

RE FE R ENC E S
Abhay Pant is a doctoral student in the
Ahamed, M. M. (2017). Asset quality, non‐interest income, and bank profit-
Department of Economics at Indian
ability: Evidence from Indian banks. Economic Modelling, 63, 1–14.
Institute of Management Indore, India.
Ahamed, M. M., & Mallick, S. K. (2017). House of restructured assets: How
do they affect bank risk in an emerging market? Journal of International His research interests include Banking,
Financial Markets Institutions and Money, 47, 1–14. Corporate Governance, Efficiency and
Chaudhuri, K., & Sensarma, R. (2008). Non‐Performing Assets in Indian Productivity analysis, and Econometrics
Banking: Magnitude, Determinants and Impact of Recent Policy Initia- and Financial Economics. He holds a Mas-
tives. India Development Report, Indira Gandhi Institute of Development
ters degree in Financial Economics from
Research, 134–144.
Gokhale Institute of Politics and Econom-
Dhar, S., & Bakshi, A. (2015). Determinants of loan losses of Indian banks: A
panel study. Journal of Asia Business Studies, 9(1), 17–32. ics, Pune, India. His prior work experience includes working as an
Harris, P., & Fleisher, C. S. (2016). Introduction: The continuing develop- Academic Associate at Indian Institute of Management, Bangalore,
ment of international corporate and public affairs. P. Harris & C. S. India.
Fleisher (Eds.), The SAGE handbook of international corporate and public
affairs (pp. 1–16). Sage.
Jensen, M. C., & Meckling, W. H. (1976). Theory of the firm: Managerial
How to cite this article: Nidugala GK, Pant A. Lessons from
behavior, agency costs and ownership structure. Journal of Financial
Economics, 3(4), 305–360. NPAs crisis in Indian banks. J Public Affairs. 2017;17:e1672.
Samantaraya, A. (2016). Procyclical credit growth and bank NPAs. Economic https://doi.org/10.1002/pa.1672
and Political Weekly, 51(12), 112–119.

49
http://economictimes.indiatimes.com/industry/banking/finance/banking/
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http://economictimes.indiatimes.com/industry/banking/finance/banking/
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