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Non-performing assets (NPAs) have become a major challenge for both public and private sector banks in India. In the exuberant milieu that started way back in 2004-05 and continued for three years until the global financial crisis
in 2008, large corporations conceived major project proposals in capital-intensive sectors such as power, ports, airports, housing and highway construction. Banks were only too keen to lend, often without sufficient evaluation of risks andreturns. Things started worsening with the policy paralysis brought about by the spectrum and coal mining scandals. Soon, most projects were getting stuck, especially in power and highways. Banks found their loans going sour, which led to the whole situation of NPAs. Initially, the extent of NPAs was hidden by ‘even-greening’. It was revealed later as the Reserve Bank of India (RBI) tightened the norms.

In the recent past too, Indian banks have been saddled with increasing levels of stressed assets and NPAs. Indian banks’ gross NPAs stood at Rs 8.40 lakh crore as on September 30, 2017. The ratio of NPAs was particularly disturbing when it came to public sector banks (PSBs).

On December 2013 the gross total of NPAs was only Rs 2.52 lakh crore out of which Rs 2.28 lakh crore was with public sector banks and a small sum of Rs 0.24 lakh crore with private banks. Currently, out of the total NPAs of  Rs 8.40 lakh crore, PSBs account for 7.34 lakh crore and Rs 1.06 lakh crore with private banks.

In this context, the RBI and the government are proactively taking steps to resolve NPA challenges in the banking sector. The government has empowered the RBI to chalk out plans for addressing the bad loans problem, with a focus on large stressed accounts that have been classified partly or wholly as non-performing from amongst the top 500 exposures in the banking system, and mandated that a dozen such accounts be taken to the bankruptcy courts.

During 2016-17, while deposit growth of scheduled commercial banks (SCBs) picked up, credit growth remained sluggish, putting pressure on net interest income (NII), particularly of PSBs, and they also continued to show a negative return on assets (RoA). The gross non-performing advances (GNPAs) of the banking sector rose along with the worsening of the banking stability indicator (BSI) between September 2016 and March 2017 due to deterioration in asset quality and profitability. The macro stress test indicates that under the baseline scenario, GNPAs of SCBs may rise from 9.6% in March 2017 to 10.2% by March 2018.

The RBI also reinforced its supervisory and enforcement frameworks by revising the prompt corrective action (PCA) framework and establishing an Enforcement Department. Once PCA is triggered by the regulator, the bank faces restrictions on spending money on opening branches, recruiting staff and giving increments to employees. Further, the bank can disburse loans only to those companies whose borrowing is above investment grades.

The Securitisation and Reconstruction of Financial Assets and Enforcement of Security Interest Act (SARFAESI) Act, 2002, was amended in 2016 as it took banks years to recover the assets.

Experts have pointed out that the NPA problem has to be tackled before the time a company starts defaulting. This needed risk assessment by the lenders and red-flagging of the early signs of a possible default.

NPA story not new

The NPA story is not new in India and several steps have been taken by the government on legal, financial and policy level reforms. Taking note of the existing stressed assets and NPS situation, the RBI introduced a host of schemes and frameworks with the aim of curtailing the growing NPAs.

As NPAs kept on increasing, the RBI rolled out quite a few measures to improve the asset quality of banks. The RBI had strong notions that some of the banks are underreporting their NPAs. Asset classification practices were not as per the set standards and several banks resorted to ever-greening of accounts. Here, banks were postponing bad-loans classification while depicting accounts as performing. To resolve this, during 2015, the RBI had conducted an inspection of selected banks’ balance sheets at random and released an Asset Quality Review (AQR) report. This report revealed a higher level of asset quality deterioration or NPAs with the inspected banks. As per the review, almost all PSBs had higher NPAs than reported. In the case of private sector banks, the impact was limited to big lenders in the industry.

The so-called Joint Lenders’ Forums (JLFs) mandated that banks adopt measures for early identification to tackle stressed loans, which gave them a jumpstart, especially in large and complex cases of corporate debt, because of differences among creditors on how best to resolve them. As per the JLF framework, at least 75% of creditors by value of the loan and 60% by number of lenders in the JLF were needed to agree to the restructuring plan. Obtaining consensus of creditors was a major bone of contention for the JLF, which in turn reduced to effectiveness of the forum.

The Strategic Debt Restructuring (SDR) mechanism intro-duced soon after was also not lucrative for lenders. While the scheme seemed interesting to begin with, it was soon evident that there were no buyers in cases where it was being invoked.

Soon after, the RBI introduced the S4A Scheme. This scheme, however, only covered projects that had already started commercial production. Further, the scheme was also silent about unsecured creditors, who could always approach a court of law and play spoilsport. Ultimately, by being unsecured creditors, they would not get their dues, but they could certainly delay the process; the banks would then lose time, precious for the revival of a company.

The revised framework, however, requires banks to identify signs of incipient stress in loan accounts and classify stressed assets as SMAs, immediately on default.

Further, banks would also have to incorporate changes in their reporting process to include the following:

The CRILC Main report will now be sent monthly, as against the quarterly frequency.

Banks will also need to submit a weekly report on all borrower entities in default with an exposure of Rs 50 million and above.

 Formation and implementation of resolution plans (RPs) by lenders

Under the revised framework, all lenders must put in place board-approved policies for the resolution of stressed assets, including the timelines for resolution. As soon as there is a default in the borrower entity’s account with any lender, all lenders – singly or jointly – shall intimate steps to cure the default. This means that the revised clause eliminates chances of banks interpreting assets. Currently, while one bank classified an account as stressed, or NPA, others continue to show them as standard. This required the RBI auditors to force show them as divergence in NPA reporting.

 RPs framed by banks against defaulting entities shall be deemed to have been implemented only on satisfaction of conditions laid down by the RBI. This involves ensuring that the borrower is no longer in default. In case the RP involves restructuring, banks will also need to ensure that all related documentation has been completed by all lenders and the new capital structure and /or terms and conditions post-restructuring are duly reflected in the books of accounts. Banks will need to disclose the implementation of RPs in their notes to accounts.

In case of RPs involving restructuring, banks will need to engage with a CRA for an independent credit evalua-tion of the residual debt. Additionally, where the exposure is `5 billion and above, banks will need to obtain two such independent credit evaluations (ICEs). Further, banks need to ensure that RPs with a credit opinion of RP4 or better only is taken up for implementation.

The new framework puts down strict timelines over which insolvency proceedings must be initiated. These timelines came into effect starting March 1, 2018.

     +    For accounts with an exposure of Rs 2,000 crore or more, banks will have to ensure that a resolution plan is in place within 180 days after a ‘default’.

     +    If the resolution plan is not implemented within 180 days, the amount must be referred to the IBC within 15 days.

     +    For large accounts where resolution plan is being implemented, the account should not be in default at any point during the specified period.

     +    If there is a default within the specified period, the lenders should file an insolvency application.

     +    For accounts with exposure of Rs 100 crore to Rs2,000 crore, a timeline for resolution will be announced over a two year period.

     +    These timelines will lead to speedy recovery of the loan from the borrower.

The revised framework lays down additional requirements for upgrading large accounts, post NPA classification. Banks will need to ensure that, in addition to demonstrating satisfactory performance, the credit facilities of the borrowers shall also be rated as investment grade (BBB or better) by CRAs at the end of the specified period.

The new framework will subsume almost all stressed asset schemes. This includes:

     +    Corporate Debt Restructuring Scheme

     +    Flexible structuring of existing long-term project loans

     +    Strategic Debt Restructuring (SDR) Scheme

     +    Change in ownership outside SDR

     +    Scheme for Sustainable Structuring of Stressed Assets (S4A)

The JLF which was overseeing stressed asset negotiations in the case of large consortium loans also stands disbanded.

With a new framework in place, the RBI aims at a harmonised and simplified genetic mechanism for the resolution of stressed assets. This framework has been introduced keeping in mind the regulator’s stance on ensuring speedy resolution of bad loans in the future. A predominant theme of the new framework is reliance on the IBC to resolve stressed assets while doing always with a number of interim schemes introduced before India adopted a bankruptcy code in 2016.

In the long run, the new reforms will bring a good structural change that can strengthen the banking system in future. A new rule will instil a sense of transparency and boost investors’ confidence in the financials of banks and change the way banks do business. There will be greater prudence in lending. Cowboy lending, especially towards larger projects where banks lack the capacity to conduct proper appraisals, could be on its way out. Chief financial officers will read loan covenants more carefully because the tolerance for defaults is being lowered considerably. They will need to ensure loan repayment terms are more realistic.

The entire process should involve a high degree of transparency and precision. With the intensity of frauds and scams increasing in the banking sector, it is essential to ensure that accuracy and integrity of reporting. There must be a strong audit framework in place to ensure that banks accurately report the required information to the RBI as well as integrate regulatory submissions like Risk-Based Supervision (RBS) and Central Repository of Information on Large Credits (CRILC) reporting. Strengthening this would ensure early and accurate identification of bad loans and NPAs and subsequent remedial action by the RBI and the government. While bank books might get worse over the next 12 months, in the long term, the new NPA rules will ensure that the books reflect the actual underlying asset quality.