Why the new banking ordinance may not be able to solve the NPA rot

The President has accorded his assent to an ordinance proposed by Cabinet giving more powers to RBI to solve the massive NPA mess. Gross NPAs of banks have risen by Rs 1.2 lakh crore in first nine months of FY17 to Rs 6.7 lakh crore as of December 2016. Top 50-60 accounts amount to the majority of the non-performing assets.

The details of the ordinance are as follows:

(i) 2 new sections 35AA and 35AB have been introduced in Banking Regulations Act, 1949.

(ii) 35AA gives powers to the central government to authorize RBI for issuing directions to banking company to initiate insolvency resolution process in respect of stressed assets.

(iii) 35AB gives power to RBI to issue directions to banking companies for resolution of stressed assets. It also empowers RBI to form committees / panels to advice banks – industry wide, specific cases.

Essentially this means that any dilly-dallying by banks in recognizing NPAs and initiating insolvency action will not be tolerated by RBI as well as government. This also highlights a fact that banks in India do not have the necessary talent to solve such complex NPA issues.

RBI will guide banks on haircuts, structuring, loan recast, etc. It remains to be seen whether RBI has the necessary bandwidth to carry on these tasks along with its regular duties. The ordinance doesn’t propose making wilful default a criminal offense as publicized. This is a dampener.

The ordinance is likely to give flexibility to banks to resolve bad accounts and give immunity to bankers from taking legal action in future. Flexibility to banks is being provided to prevent sudden shock to the economy as we will see below, cater to real problems of demand downturn and differentiate between genuine and habitual offender cases.

Immunity to bankers is being indirectly provided (as the action will be taken as per RBI directives) under pressure from industry to safeguard their interests. So that any settlement which bankers do with corporates in respect of loans is not challenged later on.

All this will require the amendment to Banking Regulation Act, Prevention of Corruption Act to make it compatible with Bankruptcy Code. These are likely to be presented in next session of Parliament.

The ordinance step is a continuation of the process which NDA government has adopted to tackle the burgeoning NPA problem. The Bankruptcy & Insolvency Act which was passed last year and hailed as a revolutionary step is struggling after a year of coming into effect. ICICI Bank filed the first case under this act against Innoventive Industries Limited to initiate corporate insolvency proceeding, however, this has been caught in a legal tangle. Further, banks are not using this route in an enthused manner as expected.

RBI under Raghuram Rajan pitched for aggressive provisioning in order to make banks ready for compliance with Basel III regulations. However, maybe he didn’t realize the enormity of the situation. Approximately 16 percent of loans and advances of banks are stressed assets (NPA + restructured accounts + write-offs). This is higher than BRICS partners except for Russia. This is alarming given that capital adequacy ratio threshold for banks is prescribed at 12 percent.

Stressed assets for public sector banks is 17 percent while for private banks, it is 7 percent and for foreign lenders, it is 6 percent. The asset quality of PSU banks is the worst amongst the lot (almost 3 times of peers).

An objective adherence to rules and assessment of accounts in stress will wipe out the significant capital of banks. As government owns a majority stake in large public sector banks, it will need to pitch in with significant equity infusion.

As per a research report, 60 percent of restructured assets convert into NPAs in 3-5 years time. So we are sitting on a ticking time bomb. If anything, this ordinance will just defer the inevitable. The policy is also in sharp contradiction of the Rajan doctrine – identify bad accounts, take a hit, record losses, move ahead with a clean slate.

The ordinance doesn’t address the basic issue as to why NPAs arise. It doesn’t provide solutions to challenges faced by banks. To ensure NPAs in future remain in control, a tectonic cultural shift and massive IT up-gradation are required. It recommends surgery without going into real issues.

The troubled accounts (NPAs) need to be broken up into (i) genuine (industry issues), (ii) willful (on purpose) and (iii) habitual offenders.

(i) genuine (industry issues), (ii) willful (on purpose) and (iii) habitual offenders.

(ii) willful (on purpose) and (iii) habitual offenders.

(iii) habitual offenders.

The genuine accounts who are unable to service loans due to a downturn in the industry and global slowdown can be given time to perform, provided their business models are robust. Strict covenants on further indebtedness should be introduced to protect the interest of existing lenders and prevent further leveraging. Banks in India are very lenient on covenants as per my experience.

The wilful defaulters need to be categorized such with alacrity. Banks in a consortium often differ on whether an account is a wilful defaulter case depending upon their exposures.

Then there are the habitual offenders. There are many promoters in India whose companies have seen many restructurings in the past. There are perennially sick companies, with massive siphoning of funds. They need perpetual public debt. These companies should not be given any fresh lease of life.

The proposed amendments would help in effectively resolving the bad loans problem, finance secretary Ashok Lavasa was quoted in LiveMint. However he added a note of caution, “It is not possible for me to put down a number on how this (non-performing assets or NPAs) will go down but certainly we feel that these changes will make the system more effective in handling the bad loans,” he said.

His statement aptly sums up the entire essence of what I have articulated in this article.

This article was originally published in FirstPost. 

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