Friday, 30 June 2017

Bank's bad loans, a global phenomenon

  • Total non performing loans (NPL), world wide, are about $3 Trillion (i.e. Rs. 200 lakh crores) i.e.  4.2% of world GDP. 
  • European banks have NPL's of 1.2 trillion Euro, Italian banks NPL's are 360 billion Euros i.e.20% its GDP & 15% of total loans.
  • In many advanced countries loans supported by artificial collateral values, real estate & equities, are face increasing risks. Debts based on low interest rates are unsustainable because any normalization threatens insolvency of over-indebted borrowers.
  • NPL problems are apparent in emerging markets viz. India,China & Brazil also. India's NPL's are over $150 billion i.e.15% of bank's assets. The problems are driven by over-leveraged borrowers, PSU's, family owned conglomerates, infrastructure companies and govt-driven trophy projects with dubious economics to which PSU banks are pressurized to lend.
  • China's NPLs are 15% of total loans i.e $1.3 trillion with potential losses equivalent to 7% of GDP (forecasts are at 20% of GDP).
  • In the past, Bank's crises are due to lending to real estate sector, leveraged buy-outs and telecommunication sectors. Current crises involves apart from these, lending to over valued housing markets and energy sector as well. Lending to energy sector alone amounts to $3 trillion, where borrowers are struggling to service the debts due to falling prices, weak growth, over capacity, rising borrowing costs and in some case cases weak currency.
  • Seeking higher returns banks have financed less-credit worthy borrowers. Abundant liquidity have increased asset prices and banks have financed against these over valued assets. Low interest rates have allowed weak borrowers to survive.
  • In developing economies, strong capital inflows seeking higher returns has encouraged increased leverage. State policies encouraged debt funded investment & consumption to create economic activity have resulted in problems.
  • Highly leveraged banking sector problems can trigger doom loop. Small loss can wipe out out significant portion of its capital increasing risk of insolvency. For example a 5% assets loss can result in erosion of capital buffer by 50%.
  • Large banking systems facilitating payments and essential supply of credit and any banking disruption could result in economic slowdown.
  • Solutions to banking crises requires capital infusion, strong earnings, isolation of bad loans and industry reforms. The ability of banks to write off losses is limited. Low & negative interest rates lower banking profitability.
  • Banks business models requires reforms for entailing consolidation and reduction of costs which are unlikely due to fear of loss of jobs and lack of competition. Access to new capital is limited. Inefficient bankruptcy procedures are barriers to new investments in banks or distressed assets. 
  • In emerging markets, reluctance to foreclose because of politically difficult business closures and job losses. Political factors are impeding recapitalization of banks.
  • After the 2008 crisis, new regulations were made to make banking system safer and eliminate the need for future tax payer financed bailouts. The success or failure of new regulations will not be known until next crisis. But in major crises still govt guarantees would become necessary for payment systems functioning.
  • The financial system acts as reservoir of deadly pathogen - bad debts  - which is spread by banks creating financial crisis.
Careful person seldom commits a mistake

My View:
Banks have deviated from traditional banking business in pursuit of higher returns indulging in high risk activities with the money which is not theirs. Underlying ethical corruption is the root cause. As long as political meddling continues banks losing money is certainty. Viability of new projects funding must be done very carefully and debt/equity ratio should be ensured in safe limits. Banks should never fund high risk financial products which are speculative in nature. There is only one way to deal with NPL's. Liquidate them at prevailing market rates and write off irrecoverable amounts. Recapitalize banks and direct them to do future banking prudently. Any other method is only postponing the eventuality and more expensive at the end.

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