Twin Balance Sheet problem remains unresolved

The twin balance sheet (TBS) problem refers to the burgeoning non-performing assets (NPAs) of public sector banks and the highly indebted corporate sector. The latest figures from RBI put the gross NPA ratio of all public sector banks at 15.6%. By March 2019, RBI has projected the NPA ratio to be between 16.3% (baseline scenario) and 17.3% (severe stress scenario). The ballooning of NPAs also puts stress on capital adequacy ratio (CAR), which at present stands at 13.5% for scheduled commercial banks and is projected to fall to 11.5% by March 2019. Meanwhile, according to Economic Survey 2016-17, around 40% of corporate debt was owned by companies which had an interest coverage ratio less than 1.

The TBS problem impedes economic growth by disrupting the demand and supply of credit (investment). It needs prompt action, else the consequences can be rough, as experienced by Japan during its “lost decades” of 1990s and 2000s.

An outburst of investment occurred from early 2000 to 2007-08, based on the promising growth trajectory of the Indian economy. The investment to GDP ratio reached the peak of 38% in 2007-08, down to 30.8% in March 2018. This credit boom (largely private) was heavily financed by public sector banks.

However, the global financial crisis changed the scenario. Growth rates plummeted, and so did the ‘animal spirits’, thus decreasing the revenues and thereby profits of the corporate sector. At the same time, the RBI came to safeguard the economy from the global financial contagion, which lead to increased financial costs to business. Thus, falling revenues and rising costs stressed the corporate sector which, in turn, led to increasing NPAs of public sector banks.

The Economic Survey 2015-16 outlined a decentralised strategy to address the TBS problem through 4R: Recognition — bank assets must be valued at their true value; Resolution -- rehabilitation or sale of stressed assets; Recapitalisation — infusion of capital through equity; and, Reform — avoiding the problem in the future.

Steps were taken to tackle the TBS challenge through the 4R strategy by introducing new schemes and strengthening already existing mechanisms like Corporate Debt Restructuring (CDR) system. Some of the measures undertaken were:

Asset Quality Review: AQR warrants banks to review loans as per RBI loan classification. The Central Repository of Information on Large Credits (CRILC), into which banks are required to upload the status of loans above Rs 5 crore periodically, has helped the RBI and the government to understand the extent of the problem.

Asset Reconstruction Companies: ARCs acquire NPAs from banks and resolve them, deriving their resolution powers from SARFAESI Act (2002).

Strategic Debt Restructuring: The SDR scheme was introduced in June 2015, under which banks could take over the defaulting firms and then sell them off.

S4A: The Scheme for Sustainable Structuring of Stressed Assets was introduced in June 2016. Under S4A, banks will hire an independent agency which will examine the debt of a company. The agency will decide how much debt is sustainable by the company and the rest (unsustainable) is converted into preference shares or equity.

Indradhanush: Under Indradhanush scheme, the government promised to inject Rs 70,000 crore into public sector banks in 2018-19.

There are other legal reforms, like the Insolvency and Bankruptcy Code (2016), which provide a legal framework to take tough decisions to tackle the TBS problem.

The overall picture of these decentralised measures shows limited success, if not failure, in tackling TBS. A look at some of these measures shows a gloomy picture. For example, ARCs face issues in making recoveries from defaulters and hence offer lower price to banks, which is unacceptable to the latter. Some banks are still in denial mode and do not recognise the true picture of their balance sheets, which impels the RBI to issue continuous circulars asking banks to review their asset quality. The poor performance of debt restructuring schemes like CDR, SDR, S4A, 5/25 have led to their closure.

As per the latest data the CDR cell, since its inception in 2001, it has approved restructuring of Rs 4 lakh crore worth of stressed assets. Out of which only Rs 84,677 crore worth of assets have exited successfully,
Rs 1,84,581 crore worth of assets exited unsuccessfully and the remaining Rs 1,32,948 crore worth of assets are live cases in CDR.

The RBI withdrew all debt restructuring schemes in February 2018 and asked banks to initiate resolution in case of default and refer to bankruptcy proceedings in case of failure in resolution. Further, the Rs 70,000 crore under Indradhanush is very little, banks need at least Rs 1.8 lakh crore. Government has committed to issue “recapitalisation bonds” worth Rs 1.35 lakh crore for recapitalisation of banks by the end of the fiscal year, but commentators have pointed out that issuing recap bonds will raise government debt and hence fiscal deficit, although it is not so reckoned by international accounting practices.

The above measures seek to address only the banking — NPA — side of the TBS problem. The other side — overleveraged companies — is an economic problem that lies both within and outside the realm of policy. Several problems faced by companies are due to global macroeconomic stress along with delays in domestic policy decisions, such as on environmental and land acquisition issues.

International experience shows that a centralised Public Sector Asset Rehabilitation Agency (PARA) can help resolve the TBS challenge. Recapitalisation of banks should be based on incentives to limit the scope of unviable banks as argued by former RBI governor Y V Reddy to reduce moral hazard. Further, bad loans should be written off bank balance sheets. Macroeconomic and other policy actions to make environment conducive to business will improve the health of the corporate sector.

(The writer is Assistant Professor, School of Economics, NMIMS Bengaluru)