Will ordinance empowering RBI on NPAs help?

The cabinet issued an ordinance recently giving Reserve Bank of India (RBI) more power to resolve the enormous problem of bad loans in the banking sector. The Section 35 of Banking Regulation Act is amended – 35AA empowers the RBI to issue directive to banks to initiate insolvency proceedings for a particular account under Insolvency and Bankruptcy Code and 35AB allows the RBI to set up oversight committees (OC) to monitor the top 35-40 largest nonperforming assets (NPAs) in value (accounting for 60% of total NPAs). The Prevention of Corruption Act is also amended so that commercially viable decisions taken by banks are not scrutinised later by investigative agencies.

The government did not set up a ‘Bad Bank’ as expected but decided to give more teeth to the existing mechanisms. We have reached a point where bad debts in banks can no longer be ignored. The banks’ NPAs have increased substantially from Rs 0.9 trillion (tn) in FY11 to about Rs 7 tn in FY17. Including the restructured assets, the total stressed asset moves to about Rs 9.6 tn.

The NPA problem did not just evolve in last few years. It is a legacy issue that goes back to mid-2000s as explained in the Economic Survey FY16-17. During the boom period of 2004-2008, India’s growth rate surged to almost double digit helped by higher-than-potential global growth. The record corporate profitability prompted firms to launch new projects, particularly in the infrastructure sector.

In order to take advantage of future opportunities and meet expected demand, corporates planned capacity expansion, took more risks and borrowed heavily. In the short period of five years from 2003-04 to 2007-08, the investment to GDP ratio jumped from 23% to 32%. Similarly, the non-food credit growth of the banks grew at an average of 30% in the four years (2004-2008) compared to 18% in the previous four years.

However, after the great financial crisis of 2007-08, the bloated demand estimates of the firms never materialised. On top of that, problems in land acquisition, environment clearances and cancellation of various licences delayed the projects or made them unviable. Lower revenue, high expenditure and high debt-servicing cost squeezed corporate cash flows. By 2015, almost 40% of the corporate debt was owned by companies that had an interest coverage ratio of less than one (that is, company's earnings were not enough to service the interest expenses). In tandem with deteriorating corporate balance sheet, NPAs in the banking sector increased.

Initially, the NPAs did not hurt growth as domestic demand helped the economy chug along at a comfortable speed. The banks also allowed the highly leveraged firms time to repay loans, helped them to evergreen these loans in the hope that demand would eventually pick up, commodity prices recover and economic cycle will turn. Unfortunately, the problem did not fade away. After eight years of kicking the can down the road, things deteriorated further.
Stressed balance sheet

This hurt the balance sheet of the PSU banks significantly. As a result, the banks with stressed balance sheet limited risk by reducing fresh loans. The credit growth reduced to a -year low and private investment contracted. The central bank acknowledged the problem in the banking sector and took several initiatives to restructure bad loans. Over the years, the RBI encouraged establishment of private Asset Restructuring Companies (ARCs), introduced Strategic Debt Restructuring (SDR) in 2015 and Sustainable Structuring of Stressed Assets (S4A) in 2016. However, none of these schemes helped due to several reasons.

First, the large proportion of stressed debt is concentrated in a few large corporate groups which became difficult to resolve.

Second, it is reported that as on September 2016, about 10 of the top 100 stressed debtors would need debt write-down of 51-75% and a whopping 57 would need reduction of around 75% to become viable. The PSU banks are unwilling to take such large hair-cuts for fear of being investigated by various agencies. The State Banks are also not in a position to take the alternative route of converting their debt to equity.

Third, the large debtors have many creditors. The RBI had created the Joint Lenders Forums (JLF) where decision can be taken by 75% of creditors by value and 60% by number. However, consensus is elusive as different banks have different credit exposure, capital cushion and constraints.

Fourth, debt write-offs will deplete banks’ capital cushion and as these are PSU banks, the government will be responsible for infusing money into these banks. The promised Rs 70,000 crore of capital infusing announced under ‘Indradhanush’ scheme is woefully small. Not much progress has been observed by the Bank Board Bureau (BBB) created by the government.

Will the new ordinance help? One major positive is that the onus of decision-making will now shift from banks to the RBI. The oversight committees under RBI will be able to take decisions on loan write-offs and thus shields the bankers from being investigated later. The PSU bankers usually come under pressure from both the powerful borrowers and their political supporters. Bankers are also penalised for taking large haircuts and thereby losing public money. It will be now easier to take tough decisions. Next, it will be uncomplicated to coordinate among bankers in JLF and push for consensus decision by the RBI.

The exact guidelines of RBI remain to be seen. There will be challenges as it might be difficult to value the assets of projects that were shelved due to delay in approvals. As most of the NPAs are concentrated in PSU banks, large haircuts will have fiscal implication. Moreover, experts fear that in the process of depoliticising the banks, the RBI itself may get politicised. The ordinance pushes the NPA problem onto the lap of the RBI. The government will have to be proactive to solve the enormous NPA issues or this ordinance will just remain a piece of new legislature.

The writer is a visiting fellow in Pahle India, research scholar at IIFT and adviser at Policy Monks