Determinants of NPAs in the Indian public sector banks: A Critique of policy reforms

Abstract

The paper analyses the process leading to formatiom and perpetuation of high levels of NPAs in Indian public sector banks (PSBs henceforth). It distinguishes between random and non-random reasons of NPAs formation in PSBs. It points out that a high degree of arbitrariness is involved in defining NPAs as it fails to capture diversity in terms of the seasonal and cyclical nature of the economic activities in India. The study conceptualises random reasons for default in a simplified framework of a Poisson process. It then argues that the nonrandom reasons go beyond the conventional paradigm of interim, ex-ante and ex-post information asymmetries and incomplete contracts. It points out that the financial notion of NPA as a mere risk phenomenon is inadequate, because a number of reasons leading to non-random generation of NPA are related to the dimension of uncertainty. It highlighted that the use of a secondary asset market may take care of NPA problem, but it requires a number of conditions for its use, which hardly exist in India. The study observes a number of reasons of generation of NPAs which are very important and peculiar to India. This is followed by a critical evaluation of the series of policy measures that have been adopted to improve the NPA scenario since liberalization. While one set of policies granting greater autonomy to the PSBs are proved to be quite effective in restricting formation fresh NPAs, the other set of policies designed to recover loans, after default, have failed to deliver the goods. Finally, it concludes by making an assessment of the existing institutions and highlights the fact that the incidence of NPA is as much due to the malfunctioning of the banking institutions as due to the external institutional environment.