State Bank of India: Cleaning up Its Balance Sheet

Banks are essentially known for transferring financial resources from net savers to net borrowers. The banking sector is a dominant player in the complex financial system of a country and provides liquidity and payment services to the real sector. As financial intermediaries,  banks are exposed to various embedded risks: market, credit, and operational risk. Secondly, banks being highly leveraged, these inherent risks are potential enough to inflict catastrophic losses unless they are managed effectively. And, at the same time the empirical studies of Levine (1997) suggests that the  economic growth of a country is positively related to the stage of financial development in terms of the size of the financial markets relative to GDP by facilitating better risk-sharing and mitigating informational problems.

It is in this context that Non-Performing Assets (NPAs)—which are nothing but loan assets of a bank that have become non-functional as the respective borrowers have defaulted in their liabilities—of a bank have become critical in defining the financial health of a bank. Here it is immaterial whether a borrower defaulted from his repayment obligations by virtue of his not being able to realize the anticipatory cash flows from the business either due to his managerial incompetence, financial inadequacy, product failure, market competition, technological obsolescence, etc. or  due to change in government policies, macroeconomic fundamentals, natural calamities, labor problems etc. or because of the fact of lending-bank’s failure to respond to a borrower’s additional capital needs emanating from the altered market reflections, well in time.  Thus, it has become critical for a bank to anticipate the possibilities of an account turning  into NPA and initiate a suitable arresting mechanism at the very initial stage itself, for that is the only way for banks to remain healthy.

Some researchers have made an attempt to analyze the movement of non-performing assets of public and private sector banks in India as impacted by the macro economic factors and bank specific factors, using regression techniques. The model developed for studying the movement of NPA factored macroeconomic factors such as GDP growth rate and excise duty, and bank-specific parameters such as credit deposit ratio, loan exposure, priority sector loans, capital adequacy ratio and liquidity ratio. The interesting revelation of the studies is that contrary to the commonly held belief, NPAs are found to decrease with the increased share of priority sector loans to total loans. The level of NPAs in public sector banks is found to be impacted by the macro economic factors, significantly.

These studies have also thrown open a new field of research for testing the impact of other important macroeconomic fundamentals such as inflation rate, interest rate and exchange rate and their variations on the accretion or otherwise of NPAs. Similarly, bank-specific parameters such as bank’s sensitivity to time, the debt restructuring rightly, or providing adequate capital in time vis-à-vis the demand emanating from the altered market conditions etc. also needs to be assessed for their impact on generation of NPAs.

Against this backdrop, it is heartening to hear that the new Chairman of SBI, Mr. Pratip Chaudhuri, has cleaned up the mess of NPAs from his bank’s books, which, of course, resulted in the bank posting a 99% fall in its fourth quarter profits. A dare devil act, indeed!

Yet, that was the right thing to do. And the right time too, for once settled, seldom does a chairman of a Public sector bank like to blow off his balance sheet or his career.  That’s what indeed happened till he took over the charge of the SBI: his predecessor swept the mess under the carpet. For that matter, it is no exaggeration to say that every chairman of a PSB does the same.    

True, his act of making huge provisions for bad loans has resulted in a dip in market price of the share, but what after all do the investors need to look for? Immediate profits, or sustainable profits over a longer period? Obviously, the answer is: profits over a longer period. And that is what the new chairman must aim at. Having cleaned the balance sheet, he should now identify high margin low risk business to build up a stream of sustainable revenue.

This is more essential in the light of stiff competition being offered by private sector banks that enjoy the benefit of operating with no hassles of ‘unlearning’ since all these banks have started on a clean slate, plus the added advantage of operating with the latest technology offering esoteric products to customers. And this perhaps holds good for every PSB: banks have to constantly clean up their balance sheets and reinvent ways and means of generating revenue.

GRK Murty