July , 2017
Bank NPA Resolution : Ordinance Route, 3-tier Strategy & much more
14:25 pm

Arijit Hazra

Notwithstanding the official figures, the overall stressed assets in the Indian banking system at this point could be as high as `12 trillion, i.e. more than 8% of India’s GDP.  The government and Reserve Bank of India (RBI) have been trying to resolve this problem for more than a year now. Quite a few schemes like the 5/25 scheme, the Corporate Debt restructuring (CDR) under Joint Lending Forum (JLF), the Strategic Debt Restructuring (SDR) and the Scheme for Sustainable Structuring of Stressed Assets
(S4A) have been tried out by the RBI so far, but none has yielded the desired results. Then, in early May 2017, the government came out with an ordinance which adds two new sections to the Banking Regulation Act, thereby empowering the RBI to act on NPAs. Under the amendments introduced (Sections 35AA & 35AB), the government can now authorise RBI to issue directions to banks to initiate insolvency proceedings in respect of a default, under the provisions of the Insolvency & Bankruptcy Code (IBC) and RBI can also specify oversight committees to advise the bank managements on this.

Many experts have felt that this is a case of conflict of
interest – after all, RBI’s mandate is to be a regulator and supervisor, and not to micro-manage banks and meddle in their decision making. If RBI is allowed to direct/advise banks on how to deal with bad loans, in future would we get to see RBI directing the same banks on where to lend? That may eventually lead to a directed lending regime.
Well, it is a valid point, but we must also remember that this is an extraordinary problem which has greatly curbed fresh lending which, in turn, can substantially slow down economic growth. Thus, the present situation calls for an extraordinary solution. It has to be kept in mind that at the root of the lack of progress on resolving the stressed assets problem has been the fear of future investigation on bank management’s decision on ‘haircuts’. For resolving the bad loans problem, banks need to get rid of such loans from their balance sheets. And such assets can find buyers only if sold at a substantial discount. To ensure that such decisions are not subject to a ‘witch hunt’ in the future, this new ordinance is expected to provide support to the decisions taken. The oversight committee is expected to provide the necessary credence and protection to the decisions taken by banks to divest their portfolio of bad loans. The ordinance is also expected to facilitate in building quick consensus for ‘haircut’ decisions where multiple lenders are involved.

As per latest information, a 3-tier strategy has been conceptualisedfor the resolution of the stressed assets. Relatively smaller stressed accounts with size of less than ` 1,000 crore are to be sold to ARCs, mid-sized accounts of ` 1,000-5,000 crore are to be resolved through the various RBI restructuring schemes and larger cases (of more than
` 5,000 crore) are to be tried at the National Company Law Tribunal (NCLT) in accordance with RBI rules, according to the latest plan.In June 2017, RBI identified 12 large stressed accounts which are to be referred to the NCLT. In other cases, RBI has asked banks to finalize a resolution plan within the next 6 months, failing which it will be filed for bankruptcy proceedings. For other smaller cases, lenders have intensified their resolution efforts in the current quarter by clearing the old stock of NPAs.

According to majority of the industry observers, this is likely to be a long-drawn process. Ideally, the job of resolving bad loans should have been left to specialist players. However, what is preventing that is perhaps the lack of a competitive market for stressed assets. The operational Asset Reconstruction Companies (ARCs) in India are not well capitalized. According to a 2016 report by EY, the capitalization of all ARCs put together adds up to around ` 3,000 crore. In the lines of the National Investment and Infrastructure Fund (NIIF) created to invest in infrastructure projects, where both government and private sector are stakeholders with the private sector holding a majority stake, new ARCs may be conceptualized and set up. Along with ARCs, players like Private Equity (PE) Funds, Vulture Funds, etc. should also be encouraged to operate in the Indian market. Chances of a turnaround of stressed assets will improve if the buyers have some profit motive. In this regard, PE Funds and Vulture Funds have a better incentive to turn around such assets. Having multiple buyers for stressed assets should allow multiple models of financing stressed asset purchases.

It is encouraging to note that the efforts to resolve stressed assets have not been restricted to the government and the central banker only. The Securities & Exchange Board of India (SEBI) is also now active in contributing to the process. SEBI has recently eased the rules for investors buying distressed companies from banks. SEBI had already exempted a bank (holding a controlling stake in a company following SDR) from having to make an open offer to
minority shareholders, as would happen in a normal
takeover. The same benefit has now been extended to
investors who buy a controlling interest in a stressed company from its lenders. This will largely encourage facilitate specialist players like Vulture Funds and PE Funds to get actively involved in the debt restructuring process.
However, the attendant riders need an urgent review. The riders call for the new investors to get approval of
shareholders through a special resolution and also
agree to a 3-year lock-in period. In case of a revival of
the asset, minority shareholders stand to gain along with the majority owners. Thus, the need for special resolution is quite useless. A lock-in period is illogical as in case of a successful revival, the specialist investors should have the freedom to exit the investment and refocus their expertise to other stressed assets. In case of an unsuccessful turnaround of the asset, it leads to liquidation. Protection of minority shareholder rights is all that
matters in such a case as long as there are no differential rights for any class of shareholders. Thus, these riders need to be dispensed with as these are counter-productive.

What also needs to be kept in mind is that the clean-up drive will lead to restructuring of loans which will call for making massive provisions that can well wipe out many banks’ capital. Thus, the ordinance can be successful only if the government is willing to pump in fresh capital. The government is to infuse ` 70,000 crore in PSBs over a period of 4 years (from 2015-16 to 2018-19), while the PSBs are to raise another ` 1.1 trillion from the markets to meet their capital requirements in line with global Basel III risk norms. The government has also imposed certain conditions for the PSBs to be eligible for capital infusion. These conditions include active bad loan management, arranging capital from the market, a continuing plan for selling non-core assets, shutting money-losing branches and temporary paring of employee benefits, if necessary. To what extent this capital infusion plan works out in reality will also be a determining factor for the stressed assets resolution process.

In addition to these initiatives, what is needed for a long-term sustainable growth of the banking sector is systemic reform. The reasons behind bad loans vary from case to case. Thus, customized solutions are needed for each. As a starting point, we need to review the composition of the Public Sector Bank (PSB) Boards. Those Boards routinely have representatives from RBI, Ministry of Finance, Chartered Accountants, professionals with legal experience, etc. What seems to be missing is the presence of people with adequate industry experience in the Board – those who can provide sectoral insights. The industry perspective is very important in taking a view of the bigger picture while evaluating project proposals and then taking credit decisions. Even after that, if a loan goes bad, the restructuring exercise should ideally be taken by an empowered committee formed by the Board. The committee can comprise of the Independent Directors. Such a committee will be better equipped in coming up with a plan. In cases where a loan has gone bad for a lending through a consortium, the committee can comprise the Independent Directors of the lending banks so that there is consensus on the restructuring plan. More importantly, the decisions of the committee are made on commercial lines
and those should not be subject to investigation later on.
RBI’s intervention through the ordinance route can only be a stop-gap arrangement in an extraordinary situation.
Ideally, RBI’s involvement should only be for a limited period and there should be a sunset clause for this ordinance. In the long-run, it is the banks’ managements and their Boards which need to carry out their functions in a professional manner. For that, PSBs need to embrace higher levels of professionalism and adopt more scientific techniques of decision making and due diligence checks. Remuneration should not act as a limiting factor in cases of attracting the right talent.

It is also worth reviewing the definition of NPAs. It does not make logical sense to have the same yardstick for NPA classification for a car loan, a home loan and a loan for an infrastructure loan. The asset classes are vastly different. For example, the number of factors that affect an infrastructure loan is much more than the other two asset classes. Thus, the risks associated with each asset class are different from the others and by that logic the definition of NPAs should also vary asset-wise.

Indian banks’ emphasis and focus on security rather than the projected cash flows while doing the credit assessments and loan appraisals is quite intriguing, especially keeping in mind the legal environment where security invocation has been long-drawn and often uncertain. Going forward, cash flows should get adequate weightage in lending decisions.

Finally, our reliance on bank credit must decrease over
time. Bond markets should be able to fuel a major portion of fresh credit growth. Interestingly, bond markets’
contribution to supply of fresh credit has jumped up recently. Of the total fresh credit of
` 9.6 trillion supplied in
2016-17, the bond markets accounted for
` 3.9 trillion, i.e. over 40% of the total new credit. Bond markets’ contribution was as low as 13% in 2010-11. However, access to bond markets remains difficult and expensive and thus large segments of the industry find it difficult to tap this route.
Thus, the government may work towards evolving a mechanism whereby the bond markets can become the bigger players’ preferred route for fresh credit. This would reduce the load on the banking system to a large extent.

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