Indian banks are going to have to take a big hit if they want to salvage some of their bad loans.
To recover over Rs 4 lakh crore ($62.12 billion) from the top 50 companies that haven’t been able to repay their debts, banks may have to take a haircut of as much as 60%, resulting in a loss of about Rs 2.4 lakh crore, according to a report by ratings agency CRISIL. A haircut, in the context of loan recoveries, is the difference between the total amount that a borrower owes and the amount he or she finally pays to settle with the bank.
But despite this heavy cost, Indian banks don’t have many options left amid a mounting pile of bad debts.
As of March, the total gross non-performing assets in India stood at about Rs 7.29 lakh crore, or around 5% of the country’s GDP. NPAs are loans with slim chances of recovery, where borrowers have stopped repaying either the principal or the interest. Meanwhile, stressed assets, which include NPAs, restructured loans and written-off assets, have ballooned to nearly Rs 10 lakh crore, accounting for around 12% of the total loans in the Indian banking system. This means that out of every Rs 100 that has been lent out by banks, they are likely to recover only Rs 88.
“The intensity of [the] haircut required on these assets is the manifestation of the challenges faced by them in the current business environment,” the CRISIL report said, noting that haircuts are required across sectors such as construction, power, metal, and textiles. “Many of these assets may not be viable anymore, therefore, cosmetic restructuring may not suffice.”
This strategy is often seen as a last resort when restructuring options such as longer repayment periods or reduced interest rates don’t work out, and there is no other hope of recovering the loans. To clean up the balance sheet, lenders may take this recourse as they are at least able to recover a fraction of the loan amount. Haircuts also reduce the total provisioning requirement, under which banks have to set aside funds for recovery once a loan slips into NPA territory. This provisioning requirement can severely impact banks’ earnings because it reduces the amount of money available to lend, and thereby limits the interest earned, which is the primary source of income for banks.
Recently, the Reserve Bank of India directed banks to take the top 12 large defaulters to the bankruptcy courts. They’ve also been asked to increase the provisioning on these accounts as a cushion. This could require an additional Rs 18,000 crore in all, according to a report by India Ratings, a research and rating agency.
So, even though haircuts are a bitter pill to swallow, they may be the best Indian banks can hope for as of now.
This article first appeared on Quartz.