No Quick-Fix Solutions for Accumulated NPAs

The amendment to the Banking Regulation Act has failed to provide relief from the government’s latest scheme for cleaning up accumulated NPAs

Those expecting immediate relief from the government’s latest scheme for cleaning up accumulated non-performing assets (NPAs) might have to wait some more. Going by some statements and interviews to media, it may have seemed that a quick-fix was at hand. Nothing could be further from the truth: what has accrued over so many years is unlikely to vanish with the mere snapping of fingers.

The government’s latest weapon against NPAs is an amendment to the Banking Regulation Act, 1949, which is expected to invest banks with some freedom in resolving bad loans without inviting the prosecutorial gaze of central investigative agencies.

NPAs have become a stumbling block in all attempts to re-ignite the economy. Bank credit growth has slowed, affecting capacity creation and expansion—bank credit grew only 5.1% during year to March 2017, against 10.3% in the previous year. The Reserve Bank of India’s (RBI’s) latest Financial Stability Report shows stressed assets (sum of gross NPAs and restructured assets) at 12.3% of assets by September-end 2016. After factoring in demonetisation’s adverse impact and the prolonged economic stasis, this ratio would have further deteriorated by March 2017. This has forced banks to turn risk-averse.

The amendment to the Banking Regulation Act is therefore expected to provide some relief. Unfortunately, the measure has failed to generate unstinted optimism as expected. The reason is that some bugs exist that could slow down progress in the short run.

At one level, the entire exercise is designed as a signalling system, indicating the government’s and the central bank’s resolve to straighten out what seemed like an intractable problem. It also signals that both parties are prepared to support banks’ attempts to resolve this crisis.

But the government itself nullified this confidence-building exercise with another adverse signal—two senior bankers heading two large public sector banks (PSBs) were transferred to smaller entities, signalling a demotion. This was done overnight, without informing either the individual bank boards or the autonomous Banks Board Bureau. Trust plays a large role in any signalling exercise and the latest order just chipped away at the first step to building trust with bankers.

The second crimp is PSBs’ lack of balance-sheet muscle to tackle the volume of NPAs. The International Monetary Fund’s (IMF) 2017 Article IV report on India shows that while aggressive NPA recognition by PSBs turned their return on assets negative in 2015-16, aggregate provisioning coverage ratio still remained low, indicating weak capital bases. The IMF report also shows that PSBs are content writing off loans rather than recovering them—a commentary on the numerous, though deficient, stressed asset resolution mechanisms. The short point is this: banks are unlikely to get aggressive with NPA resolution unless there is capital within sight.

The government, on its part, has drawn up a three-pronged plan to meet its capital infusion responsibility: limited capital infusion depending on performance criteria, merging some of the larger banks, and asking banks to source balance capital from capital markets. All these measures are time-consuming and the pace of capital flow is likely to determine the speed of resolution.

The third problem lies in the wording of the amendment. The government has inserted Section 35AA in the Act, which states: “The Central Government may by order authorise the Reserve Bank to issue directions to any banking company or companies to initiate insolvency resolution in respect of a default, under the provisions of the Insolvency and Bankruptcy Code, 2016.” This is followed by a paragraph stating, “Without prejudice to the provisions of section 35A, the Reserve Bank may, from time to time, issue directions to the banking companies for resolution of stressed assets.” The RBI will also create committees of experts to advise banks.

Two issues spring to mind immediately.

First, the amendment does not explicitly insulate bankers from future persecution, nor is there any implicit signal. The Prevention of Corruption (Amendment) Bill, 2013, which includes provisions for such a shield, is stuck in Rajya Sabha. Therefore, till there is clarity on where the buck stops—the Centre, the RBI, the committee of experts appointed by RBI or the bankers—progress is likely to be slow.

Second, the amendment is unclear about how the Centre proposes to take the resolution forward: will the government monitor each individual asset resolution or provide an umbrella order enabling the RBI to calibrate its action depending on the merits of each case?

Both possibilities have consequences. In the first instance, there are risks of government being accused of cronyism. In the second, the central bank (or its appointed committee) will be exposed to scrutiny from investigative agencies, which may be detrimental for any central bank.

Finally, if all the above do fall into place, there is still one snag: capacity constraint at the National Company Law Tribunals. Of the 700 cases filed with the tribunals, only 70 have been admitted. Moreover, the National Company Law Appellate Tribunal has ruled (as reported by this newspaper) that the 14-day deadline for admitting or rejecting a proposal is not binding, though once admitted, the case has to be resolved in the mandatory 270-day period.

Make no mistake: there is definite movement towards resolution. But, as mentioned earlier, do not expect miracles.

This article was originally published in Mint newspaper on May 17, 2017, and can be read here

NPAs: The New Wedge in Centre-State Relations

NPAs are expected to acquire a two-tier, federal character with enormous implications for Centre-state relations

There was jubilation in stock markets recently after finance minister Arun Jaitley hinted at a scheme to sort out the messy tangle of bad loans in the banking sector. The equity market’s optimism beggars belief because NPAs—or non-performing assets, as bad loans are called technically—have remained impervious to an alphabet soup of previously attempted schemes. And now, NPAs are expected to acquire a two-tier, federal character with enormous implications for Centre-state relations.

In the post-1991 era, multiple schemes have been conceived and launched to tackle the menace of NPAs: DRTs (debt recovery tribunals, as suggested by Narasimham Committee-I and then subsequently amended in 2012), CDR (corporate debt restructuring), SARFAESI Act (Securitisation and Reconstruction of Financial Assets and Enforcement of Security Interest), CRILC and JLF (Central Repository of Information on Large Credits and Joint Lenders’ Forum), 5/25 scheme, ARC restructuring (asset reconstruction companies, formed as a consequence of DRTs), SDR (strategic debt restructuring), AQR (asset quality review), S4A (scheme for sustainable structuring of stressed assets) and finally the IBC (Insolvency and Bankruptcy Code).

There are multiple reasons for many of these schemes failing, which includes an inadequate legal framework for pursuing resolution; however, the one reason that remains unchanged from pre-reforms period is final policy design always providing corporate borrowers enough protection so that they can reprise the same act all over again. And while public attention has focused on Vijay Mallya—deservedly of course—there are other larger industrial groups which are habitual offenders but manage the system adroitly. Former Reserve Bank of India (RBI) governor Raghuram Rajan was compelled to state: “…it is extremely important that banks do not use the new flexible schemes for promoters who habitually misuse the system (everyone knows who these are) or for fraudsters.”

This raises issues of “moral hazard”; in the Indian context, moral hazard has taken the form of corporates or public sector banks undertaking increasingly riskier behaviour because they know the government is underwriting that risk or bearing the cost of that risk. Post the 2008 financial crisis, moral hazard has acquired some flexibility globally: it has become acceptable to bail out institutions if government feels such failure can lead to widespread systemic risk.

This may have inspired finance ministry’s chief economic advisor Arvind Subramanian to blithely suggest that government should perhaps bail out large corporate borrowers because that is how “capitalism works”. He feels only write-offs can sort out the “mountain of debt” sitting on bank books, or settle the twin-balance sheet problem (over-leveraged companies and NPA burdened banks). 

Interestingly, Subramanian has also contributed to the NPA soup cauldron: the annual economic survey recommends the creation of PARA, or Public Sector Asset Rehabilitation Agency. Not to be left behind, even RBI’s recently appointed deputy governor Viral Acharya has gamely added his two-bit: PAMC (Private Asset Management Company) and NAMC (National Asset Management Company).

So, while attempts are being made to untangle the knotted skein of corporate bad loans, albeit through an ever-growing thicket of acronyms, Jaitley has at the same time flatly turned down requests for farm loan waivers. He has received wide support. State Bank of India chairman Arundhati Bhattacharya has warned that fulfilling such pre-election promises might lead to dilution of credit discipline: borrowers might tend to defer repayment till the next elections in the hope of loan waivers. This newspaper also recently pointed out that the Indian agricultural sector needs long-term structural investments, not short-term exchequer-funded loan waivers. There is merit in each of these arguments.

But, here’s a catch: the ruling Bharatiya Janata Party also promised farm loan waivers in its Uttar Pradesh assembly election manifesto. Having won the elections and faced with the prospect of fulfilling that promise now, Jaitley has used an escape hatch to wriggle out of the commitments. Answering the debate on Finance Bill in Rajya Sabha, he has asked individual states to foot the bill for farm loan waivers. He has effectively created a two-tier, federal, moral hazard framework: Centre’s responsibility to bail out large corporates and states get to write off farm loans.

This further complicates attempts at creating a long-term, sustainable set of solutions for controlling and resolving the financial system’s NPAs. It also adds new headaches to the already vexed Centre-state relations. Competitive waiver promises have already weakened the fragile balance sheets of Andhra Pradesh and Telangana. 

It also raises issues of discrimination. If the Centre wants to bail out some 30-40 large corporate borrowers on the pretext that their debt misery was the outcome of external shocks, does not the same logic or argument apply to farm loans, especially since many states have been victims of droughts, inadequate monsoons and crop failures? There is no doubt the NPA mess needs to be resolved urgently to kick-start investments and the growth process. But then, that solutions framework cannot be built on the foundation of discrimination and selective relief.

The above article was published in Mint newspaper and can also be read here