Why NPAs are not just about bank governance

Source– The post is based on the article “Why NPAs are not just about bank governance” published in The Indian Express on 12th October 2022.

Syllabus: GS3- Economy

Relevance– Banking sector

News– The article explains the cause behind higher NPAs between 2011-18.

By the late 2000s, NPAs, as a percentage of gross advances had decreased to less than 3.5 per cent. It began to rise in 2011 and peaked at 11.18 per cent in 2018.

Governance issues that stem from government ownership are cited as reasons for higher NPAs.

Why are governance issues not solely responsible for stressed balance sheets?

The government ownership doesn’t explain the improvement on performance of banks during the 2000s.

Most of these NPAs arose due to defaults by private sector non-financial firms.

The difference in the business models of public and private sector banks has not been considered. At the beginning of the 2010s, public sector banks had significantly higher exposure to commodity-sensitive sectors such as iron and steel and textiles compared to private sector banks.

How the fall in commodity prices is responsible for the stressed balance sheet of banks?

The rise in NPAs coincides with fall in international commodity prices. Earlier fall in commodity prices during the late 90s also led to a rise in NPAs. But it was not as severe as between 2011-16.

During the pandemic, the balance sheet was not stressed despite the economic crisis. It can be attributed to the rise in commodity prices during the pandemic.

Decline in commodity prices leads to a decline in raw material cost. But it also causes a more proportionate decline in sales revenue. It impacts the profitability of firms.

The banks which experienced a higher decline in prices also experienced higher NPAs. Public sector banks generally had higher exposure to commodity-sensitive sectors. They experienced a relatively higher decline in prices and a bigger rise in non-performing assets between 2011-16.

What can be done?

We can create a nominal price index using data on banks’ sectoral exposure and commodity prices. For each bank, we multiply the exposure with the sectoral price in that year and the sum of all sectors provide the nominal price index. It will capture the bank-wise variation in their exposure to commodity prices.