Even as the efforts made by Modi – government including an asset quality review (AQR) by the Reserve Bank of India (RBI), enactment of the Insolvency and Bankruptcy Code (IBC), amendment of the Banking Regulation Act (BRA), massive capital infusion in public sector banks (PSBs) etc were beginning to yield results in terms of reduction in non-performing assets (NPAs) – a euphemism for loans turning bad – the crisis triggered by Covid – 19 has turned the clock back.
According to a report by India Ratings and Research (Ind-Ra), the impact of Covid-19 and the associated policy response is likely to result in an additional Rs 167,000 crore of debt from the top 500 debt-heavy private sector borrowers turning NPAs between 2020-21 and 2021-22. Together with Rs 254,000 crore anticipated prior to the onset of the pandemic, the cumulative quantum will be Rs 421,000 crore. As proportion of the outstanding debt, the NPAs will increase from 11.57% to 18.21%.
Ind-Ra has also projected a scenario wherein funding markets would continue to exhibit heightened risk aversion. Under this scenario, the corporate stress could increase further by Rs 168,000 crore taking the cumulative NPAs to Rs 589,000 crore by the end of 2021-2022. This translates to 20.84 per cent of the outstanding debt.
To deal with the impending alarming situation, in May, 2020, the banking sector, led by the Indian Banks Association (IBA), had submitted a proposal for setting up a ‘bad bank’ to the ministry of finance (MoF) and the RBI, proposing equity contribution from the union government and banks. This was based on an idea mooted (in 2018) by a committee headed by former Chairman, Punjab National Bank (PNB), Sunil Mehta for setting up an asset management company (AMC) to be named ‘Sashakt India Asset Management’ for fast ‘track resolution’ of large bad loans.
Before, we analyze the proposal, it is important to take stock of what all was done in the last 5 years or so, to deal with NPAs.
First, it was a scheme nick-named 5/25 introduced in December 2014, under which maturity of loans given to infrastructure companies could be extended up to 25 years. Second, in June, 2015, this was followed by a scheme for “Strategic Debt Restructuring” (SDR). Under SDR, banks could convert debt in to equity and take control of a company and sell off the assets. They were required to sell within 18 months; if they could not within this period, full provision has to be made.
Third, in 2016, under a “Scheme for Sustainable Structuring of Stressed Assets” [S4A], for large accounts involving borrowings of Rs 500 crores or more, where no malfeasance is seen, lenders were required to first segregate existing debt of a company into “sustainable” (the share which can be serviced with subsisting low cash flow) and “unsustainable” which can’t be serviced. The unsustainable portion (up to 50% of total debt) was to be converted into equity shares.
The underlying theme in all the three was to make banks bear the burden of bailing out borrowers in first, by almost indefinitely deferring repayment; second, by extinguishing entire outstanding debt (via converting this in to equity) and third, by condoning 50% of total debt and very little chance of recovering even the balance as the promoter’s shareholding is reduced to minority. Either, the banks were stuck with dud assets as in SDR or scheme failed to take off as in S4A. No wonder, on February 12, 2018, the RBI abolished all the three schemes.
It also issued an order requiring that in respect of accounts with aggregate exposure Rs 2,000 crore and above, as soon as there is a default in the account with any lender, all lenders – singly or jointly – shall initiate steps to cure the default by preparing a resolution plan (RP). The RP approved by all lenders had to be readied within 6 months from the default date. If, the deadline was missed, proceedings under IBC were to be initiated by referring the case to the National Company Law Tribunal (NCLT) who would get 6 months to complete the resolution process.
This indeed was the way to go. The mechanism under IBC has yielded good results with dozens of NPA accounts resolved and lenders recovering over Rs 300,000 crore. But, the circular was quashed by the Supreme Court (SC) on April 2, 2019.
On June 7, 2019, the RBI issued a revised circular. Under it, from the day an account is in default, lenders get 30 days to enter in to an inter-lender agreement [ILA] to decide on a RP. Unlike the February, 2018 circular, which set a deadline for finalizing RP, this order prescribes no time limit. It only requires them to make an additional provision of 20% if RP is not ready within 180 days and a further 15% if not ready within 365 days. The plan has to be approved by 75% of the lenders by value and 60% by number.
If, lenders don’t come up with a plan and eventually decide to refer the account to NCLT then, the provisions can be reversed viz. 50% of it at the time of initiating the proceedings under IBC and the balance when the case is admitted by the Tribunal.
In short, the June 2019 circular gives a free hand to the lenders in deciding when to go under the IBC process (additional provisioning 15%/35% for the delay in making reference is no deterrent). It has literally rendered the resolution under IBC dysfunctional. When, the NPA account is not allowed to reach NCLT within a reasonable time frame, how can action begin? The lock-down forced by Covid – 19 pandemic and consequential policy actions by the RBI granting moratorium on loan repayments and exclusion of the moratorium period for the purpose of declaring the concerned accounts as NPA has only made matters worse.
In this backdrop and the quantum of NPAs threatening to increase sharply, the worry of banks is understandable. Hence, the idea of a ‘bad bank’ has been resurrected. Will this help in addressing their concerns? Is not there a better alternative?
A bad bank buys the NPAs and other illiquid holdings of other banks and financial institutions (FIs), thereby help clear their balance sheet. The most crucial component of this transaction is the value at which the loan account is transferred. From the IBA proposal which wants the union government to be a majority shareholder (and balance shares to be held by banks having stressed loans), it would appear that the banks are keen on securing maximum value for the assets transferred to the bad bank.
Put simply, the banks don’t want to make any efforts on their own and would expect the so called ‘bad bank’ to take over the entire burden and let the latter take all the pains to recover the money from delinquent borrowers. Even if, the bad bank is unable to recover (a more likely scenario) and itself gets into trouble, the sovereign government being the majority shareholder will eventually foot the bill.
Surely, this is not the way to go. This easy and effortless option must be avoided. If, ultimately the government has to foot the bill, this can be done even while loans remain on books of the bank; there is no need to create a dedicated institution (read: bad bank) and incur additional cost that goes with it.
It is therefore, no surprise that the government is not inclined to accept the proposal submitted by the IBA. Its view is that bad loan resolution should happen in a market-led way, as there are many asset reconstruction companies (ARCs) already operating in the private space. The other argument is that already, it has significantly capitalized state-owned banks in recent years (having infused Rs 265,000 crore during the last three financial years) and pursued consolidation in the PSU banking space.
The government should stick to the stance. It should resurrect the IBC process and take proactive measures to strengthen it. The leeway given to banks via the June, 2019 circular should be taken away. The RBI should insist on a timeline for finalization of RP (as under February, 2018 circular). This can be done at the beginning of 2021-22 when economic recovery is expected.