New RBI norms to usher in structural reforms

In 2008, during a discussion on subprime lending, a public sector bank chief made a tongue-in-cheek, yet profound, statement. “It is very easy to be a lender, but recovery is a completely different ball game,” he remarked.

He did not elaborate upon the topic, and my repeated attempts over the years failed to nudge him to do so. In 2013, in an unexpected meeting, I quizzed the gentleman, by then retired, once again on this. His response was cryptic: “Bankers keep some notes very close to their heart. These notes have the jottings of IOUs (I owe you).”

It is this conversation that I’m reminded of post the Reserve Bank of India’s tightening of norms on non-performing assets (NPA) on Monday, wherein the central bank made the insolvency and bankruptcy code as the main mode to resolve bad loans, disallowing methods such as corporate debt restructuring, framework for revitalising distressed assets, flexible structuring of existing long term project loans, strategic debt restructuring scheme (SDR), change in ownership outside SDR, and scheme for sustainable structuring of stressed assets (S4A).

The former banker may not have revealed much, but as they say, a banker speaks less yet tells more.

Back in those days, corporate debt restructuring (CDR) was the preferred method to resolve corporate NPAs. “More than the performance of the bank, it was the legacy of the leader [bank chief] that mattered,” a leading financial services consultant told me in a separate meeting, without wishing to be named. “The bosses would call each other for a bailout,” he said.

In other words, if a borrower is on the verge of turning into an NPA, the banker would call upon another bank to sanction and disburse a loan in an escrow (earmarked) account for the borrower. Thus, the first banker gets a breather on earmarking an account as NPA, thereby saving his reputation. And this cycle continues, with another bank chief coming to save the reputation of a comrade—at the cost of each bank’s long-term health. Hence, the IOU note.

“This bandage approach to an ailment that requires surgery will cost the system very dearly,” the consultant then warned.

Cut to today, India’s gross NPA is estimated to be close to Rs 10 trillion.

And that’s why RBI’s new norms matter. “All accounts, including such accounts where any of the schemes have been invoked but not yet implemented, shall be governed by the revised framework.” RBI notified on Monday.

Rating agency CRISIL says the new framework for the resolution of large stressed assets has the potential to change how banks monitor and resolve NPAs. “The revised RBI framework sets in motion a change in the paradigm of stressed assets resolution,” says Krishnan Sitaraman, senior director, CRISIL Ratings. “The streamlining of the NPA resolution process affords simplicity, timeliness and credibility, so is a long-term positive for the banking sector,” he adds.

Highlighting that the gross NPA and standard restructured advances of banks are estimated at 12.6% as on September 30, 2017, ratings agency ICRA says the new framework is likely to increase the reported NPA levels of the banks in coming quarters. “While in the short-term this will increase the pain for the borrowers as well the lenders, early identification of stressed [loans] and resolution will prevent future evergreening of loans, and ensure a good financial health for the banking system in long-term,” says Karthik Srinivasan, group head, financial sector ratings, ICRA.

With 40 large accounts, accounting for nearly 33% of the gross NPAs of the banks, already under the National Company Law Tribunal (NCLT), lowering the threshold for resolution to Rs 2,000 crore per borrower will increase the overall quantum of debt being resolved on a fast-track basis. As per data compiled by ICRA, the total borrowings of the 50 large borrowers with banking exposure of Rs 2,000 crore or more, and who will need resolution by September 1, 2018, stand at Rs 2,46,000 crore. “Some of these accounts are already classified as NPAs and may not add to overall stock of NPAs. However, if the resolution plan entails restructuring of the loans, the standard loans will get classified as NPAs,” ICRA said in a note. “Also, if the resolution plan fails to get implemented by September 1, 2018, the banks will need to initiate proceedings under Insolvency and Bankruptcy Code (IBC) against these borrowers,” it adds.

Ashish Gupta, Kush Shah and Anurag Mantry, research analysts with Credit Suisse, expect another Rs 1,50,000 crore (or Rs 1 trillion) of NPAs to be with NCLT in next six months. This would be in addition to the current Rs 3,50,000 crore of NPAs under NCLT.

The trio adds that the government’s planned capital infusion of Rs 2,10,000 crore in PSU banks would suffice if 70% of their loans were assumed to slip to non performing loans, and loss given default (LGD) were contained at close to 60%. In that case, PSU banks' provisioning needs would be close to Rs 1,20,000 crore.

The new norms could have a near- or medium-term negative impact on the banking sector’s earnings, according to a research note by ICICI Securities. “Rise in bond yields along with higher provisioning will keep earnings muted, especially for the PSU banks,” says the note co-authored by research analysts Kajal Gandhi, Vasant Lohiya, and Vishal Narnolia of ICICI Securities. “The recently allocated capital should largely be consumed for cleansing of balance sheets and growth capital remaining a constraint,” the trio warns. “However, in the long-run, it is a good structural change that can strengthen banking system in future,” they add.