Lessons from Twin Balance sheet problem
- July 4, 2023
- Posted by: OptimizeIAS Team
- Category: DPN Topics
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Lessons from Twin Balance sheet problem
Subject :Economy
Section: Monetary Policy
What is the twin balance sheet problem
- A twin balance sheet is a scenario where banks are under severe stress and the corporates are overleveraged to the extent that they cannot repay.
- This generally happens in a boom cycle when the banking system provides easy credit flow to the corporate sector which too keeps taking loan (debt increase relative to equity = leverage increase).
India’s TBS story:
- As a result of excess credit expansion from 2000-2008 the Public Sector banks (PSBs) were pushed into severe stress due to high levels of non-performing assets (NPAs), high provision requirements, low profits, and low capital adequacy ratios (CAR).
- The corporates were equally under stress due to over-leveraged balance sheets to the extent that they could not repay their loans.
- PSBs had to resort to the restructuring of loans and evergreening of NPAs (giving of a new loan to take care of the earlier bad loan). This was more pronounced beginning 2008-09 following the global financial crisis.
- RBI intervention- detection to peak:
- introduced the Central Repository of Information on Large Credits (CRILC) to enable banks to share information on loans of Rs.5 crores and above.
- Data of Special mention Accounts (SMA -0/1/2) where overdue loans of up to 30/60/90 days were to be captured, reported, and monitored by banks.
- These sets of information played a big role to curb the further pile-up of NPAs with proactive intervention and follow-up of loans.
- RBI brought in stricter norms on restructuring of loans to remove the tendency of evergreening of loans.
- For independent assessment of NPA’s RBI implemented an asset quality review (AQR) – a special audit of NPA classification in September 2015. AQR classification of NPAs as per prudential norms, found the total gross NPAs in the banking system at Rs. 10.3 trillion working out to 11.5 percent by FY18.
- The combination of PSBs loaded with high NPAs and over leveraged balance sheets of corporates posed further challenge.
- introduced the Central Repository of Information on Large Credits (CRILC) to enable banks to share information on loans of Rs.5 crores and above.
- RBI intervention- resolution and recovery:
- The solution was infusion of large capital in PSBs. A set of bank reforms was set as the precondition for this infusion
- Another measure was the ‘Enhanced Access to Service Excellence’ (EASE) reforms in PSBs in collaboration with BCG in January 2018. The format of EASE reforms got modified from year ago to moving the model from EASE 1.0 to EASE 5.0 now in use.
- During 2017-21, there were large-scale mergers among PSBs bringing them down from 27 to 12 and turning them into stronger entities with potential higher risk appetite.
- National Asset Reconstruction Company Ltd (NARCL) – Bad bank also had to be formed to tackle toxic assets.
- The measures were helped by the Insolvency and Bankruptcy Code.
Lessons from TBS:
- Addressing the twin balance sheet problem in an appropriate manner has now helped India achieve a Twin balance sheet advantage for growth.
- provision coverage ratio (PCR) from 40.1 percent in June 2016 to 74 percent in March 2023
- gross non-performing assets (GNPAs) of banks sharply fell from 11.5 percent in FY18 to 3.9 percent in FY23
- The stakeholders need to learn from the TBS and avoid excess risk taking.
- The tools of risk governance, such as a sub-committee of the board on risk management along with systemic controls and monitoring mechanisms are essential to avoid such a trap again.
Banking stability indicator (BSI)
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