Non-performing assets or NPAs have been one of the biggest problems facing the banking sector the past few years.
NPAs are loans that haven’t seen any repayment activity for 90 days. While we here of companies like Kingfisher and other big corporations, there are a wide range of companies that have turned NPAs for a wide variety of reasons. Most of us would like to believe everyone is corrupt and that all parties colluded and had a blast on public money. That is just one reason among the many.
One of the biggest reasons why loans that are most likely to turn NPAs are issued is due to asymmetry in information.
Asymmetric information is a scenario where one party has more relevant information than the other. More often, this information is kept hidden. Suppose a company knows it is in a really bad spot financially but desperately needs money in order to turn things around or keep the company going. It could hide this information while submitting documents while applying for a loan. These documents reflect the historical position rather than the current position. This allows information asymmetry to seep in.
Information asymmetry leads to adverse selection and moral hazard. Since that critical information was not known to the bank, a loan was advanced. The bank chose a company more likely to not repay the loan at an interest rate different from what it would have charged had it chosen to extend the loan. On the borrowers’ part, since some money has come in, there could be motive for the promoters to siphon off the funds and leave as the ship is sinking anyway.
Closing the information gas is the solution to such situations. This is why numerous checks are carried out and many documents are submitted. However, there is still some gap in this as it relates to a transaction only at a point in time and in one bank.
One of the organized responses to bridging the information gap is to create a credit registry, be it public or private. By ensuring the flow of information, these inefficiencies can be reduced. Reducing this would mean that the right person gets the loan and the lender gets repaid. There are numerous benefits from a system perspective such as increased stability, better supervision, better policy outcomes, etc.
There is growing debate about the creation of a public registry in India. As of now, there are numerous credit information repositories that cover focus on different issues and cover different aspects. There are private companies that also engage in the business of credit registry. These companies aggregate the information collected by the other repositories. Based on this data, services such as credit scoring and analytics are provided to clients.
The biggest challenge under the current system is the decentralized nature of the repositories. Since the transactions are kept in silos based on the borrower, creditor and instrument, it is difficult to get a holistic and complete picture about the borrowers from a systemic perspective.
A centralized public credit repository that tracks and stores all the information arising from transaction carried out by various financial institutions such as banks, NBFCs, etc. while also looking at other types of borrowing is extremely critical given our current predicament. The technology to carry out such a venture exists.
What this system will do is enable real-time monitoring of risk in the system and enable institutions to make informed decision. There are 11 banks under the RBI’s Prompt Corrective Action (PCA) framework with a possibility of 6 more banks being included. Such instances can be averted with the flow of information.
Weak banks are being merged with strong bank in order to prevent them from failing. Their failure arises from their having made loans which weren’t viable. If the information were absent, the advances were made based on discretion.
This leaves scope for doubt of corruption, if not the act itself. At a systemic level, this is bad for the economy. Modern economies are built on trust. With banks repeated violating the trust of its shareholders and depositors, the system is put at risk. There are issues such as data security and privacy which are important in today cyber world. Such challenges must be addressed with strong and robust IT infrastructures in place.
What such a registry will do is enable such information checks to be a part of the lending process. This then reduces the scope of discretion in cases where over indebtedness is obvious. This will also help small and medium enterprises who maybe neglected now because of their size and the lack of recognition. A solid track record will itself become the basis of a loan rather than a brand name or fancy top line numbers. The data shared by the registry shouldn’t be misconstrued for advice or judgment being passed. Banks will still have to take a call on the loan, after all they are the custodians of the depositors’ and shareholders’ money.
On the 6th of June, the RBI announced it would be setting up such a registry. The implementation of such a registry will also help in the ease of doing business report as it is one of the criterion laid out by the world bank while scoring and ranking countries. With the implementation of this move, we could expect to jump a few slots. The future debate in this is whether the public agency should have a monopoly over such information?
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