Bad loans are one of the reasons of the suffering of Indian banks because of higher provisions, deterioration in asset quality, higher slippages and thus lower earnings.
A Global Financial Stability Report released by the International Monetary Fund (IMF) pointed out that Indian banking sector comes out as worse-off compared to other emerging economies in terms of little bank capital that it has set aside to provision for losses on its assets.
Undoubtedly, India's Rs 75 lakh crore banking system is grappling with serious problems and the situation appears to be spinning out of control. The gross NPAs have jumped from a low of 2.5 per cent in 2011/12 to a high of 10 per cent in 2016/17.
Stressed loans, which include gross NPAs plus the restructured loans under various resolution schemes, is estimated to be anywhere between 18-20 per cent.
Experts put the stressed loan figure conservatively at around Rs 14 lakh crore. They warn that the country's bad loan situation could choke its growth because banks are the only major source of funding for private investment.
However, going by the Arun Jaitley's comment from yesterday evening, it seems like that the government and the RBI have worked out a plan to fix the problem through an ordinance.
Finance Minister Arun Jaitely declared that a major decision was taken related to the banking sector. However, he declined to comment on the contents of the resolution stating tradition.
"There is a convention that when some proposal is referred to the President then details of it cannot be disclosed till it is approved. As soon as approval comes, details will be shared," he said.
But are there other options?
Learning from the global history, it is high time for India to think out of the box or borrow tested global models. Many experts feel that setting up a bad bank will be a bold and radical idea. But then there are also fiscal constraints in supporting such an initiative. In the past, the government has struggled to recapitalise banks.
Some PSB bankers cite Uttar Pradesh government's move to waive farm loans of Rs 36,500 crore by way of Kisan Rahat Bonds as an example, asserting that "when there is a will, there is a way". Undoubtedly, the current BJP-led NDA government has acted decisively on some fronts.
It has formed a professional body, Banks Board Bureau (BBB) for appointment of CEOs of PSBs, initiated privatisation of IDBI Bank and merger of five associate banks of SBI. Early last year, the finance ministry itself floated the idea of a stressed assets fund. A year later , the economic survey suggested a bad bank in the form of Public Sector Asset Rehabilitation Agency (PARA). More recently, Viral Acharya, the new Deputy Governor of RBI , echoed the sentiments of chief economic advisor Arvind Subramanian and suggested two asset management companies.
Acharya has suggested a Private Asset Management Company (PAMC) for stressed sectors such as metals, infrastructure and textiles, where the assets are likely to have economic value in the short run. He has also proposed a National Asset Management Company (NAMC) where the problem is not just one of excess capacity but possibly also of economically unviable assets in the short to medium term. He cited power companies as fit for NAMC because the projects are under utilised due to raw material shortages and lack of power purchase agreements.
A. K. Khandelwal, a member of BBB, says that while global models can be a good guide, in a country like India these resolution models cannot be aped per se. "The idea of bad bank deserves informed deliberations among all stakeholders. However, one has to take into consideration the moral hazards in creating a bad bank," says Khandelwal. Ashwin Bishnoi, Partner at Khaitan & Company, a leading law firm, also cautions that any form of bad bank would need to ensure returns for tax payer money being deployed, incentivise banks to sell their NPAs besides grappling with issues of moral hazard.
New ARC Model: A Right Fit
If funding is a big issue for a bad bank or an AMC model, the existing ARC structure is ideal for helping in resolution. The ARC model of part cash and part security receipts also works well for banks which are hugely under-capitalised to take haircuts. Some cite the UDAY power bond as a precedent where a banks loan to state electricity boards were converted into investments in its books. Many may argue that the ARCs, with a decade-long presence, haven't been successful in resolution.
But Siby Antony, who heads Edelweiss ARC, the largest ARC in the country, says many constraints for them have been removed only recently. Last week, the RBI has increased the net owned fund requirement from Rs 2 crore to Rs 100 crore in order to weed out smaller players. The government has also permitted 100 per cent FDI in the ARC model.
Foreign players are already trooping into India. For instance, US-based private equity firm JC Flowers & Co. has joined hands with the Ambit Group to acquire stressed assets in India. US-based KKR, which also has a private equity business in India, too is interested in the ARC model.
The minimum upfront requirement for sale of bad loans has also been increased from 5 to 15 per cent to encourage banks to hand over assets to these specialised agencies. "The legal framework of a Bankruptcy Code is also in place especially for ARCs because they are the ones who aggregate the debt," says Antony. In any case, ARCs would help in taking only part of the burden. "In instances where the debt is less than Rs 10,000 crore, an ARC structure may be best suited to handle it. Where the debt is very high, say Rs 30,000 crore or Rs 40,000 crore, ARCs may not be ready today," says Antony.
Size, Sector Matter
Speed in resolution is of essence since assets deteriorate very fast. Today, large loans are actually the problem area. They are concentrated in select sectors such as steel, power and infrastructure. Bhushan Steel, for instance, with over Rs 40,000 crore of debt is awaiting restructuring under S4A for a long time.
The steel major is making losses and has been severely impacted by the global glut in steel and dumping by Chinese players. This Delhi based company was also impacted by the coal block cancellation by the Supreme Court. There is already news of Vedanta and JSW Steel being in talks with lenders for a buy out, but the company has denied such reports. Similarly, many other large steel projects are facing similar sector specific issues and need immediate injection of capital.
On Wednesday, a new policy that aims to achieve steel making capacity of 300 million tonnes by 2030 with an additional investment of Rs 10 lakh crore got the Cabinet green light.
The Cabinet also approved a policy for use of domestic steel products in government organisations. "The Union Cabinet chaired by Prime Minister Narendra Modi has given its approval to the National Steel Policy (NSP) 2017," the steel ministry said.
In fact, RBI Deputy Governor Acharya's NAMC model resonates well with a sectoral approach. Experts argue that a bad bank or AMCs won't work in the current scenario. "We need a surgical strike by identifying and narrowing down the problem assets," suggest a senior foreign banker. "Unlike other countries, we have significantly high level of NPAs in few sectors.
These sectors have also suffered from non-financial reasons such as Supreme Court decisions. So while a bad bank solution would help, we also need a policy stimulus for these sectors," suggests Ashwin Bishnoi, Partner, Khaitan & Company, a leading law firm. In the past, the government has taken steps like anti dumping duties on steel imported from China and South Korea, providing some relief to steel companies.
"The Cabinet... has approved the policy for providing preference to domestically manufactured iron and steel products on government procurement," the Steel ministry added in another statement.
The banks expect the government to take similar steps in the power sector such as guiding State Electricity Boards (SEBs) to sign long term power purchase agreements (PPAs). Currently, SEBs are staying away from PPAs because of availability of cheap power over the power exchanges.
Along with the sector specific approach, the government is also focusing on resolving the problems of large companies. In fact, bulk of the NPAs are from few large corporates. "It is not that hundreds and thousands of businesses have created this problem. The problem of big NPAs is confined to essentially 30-50 companies. Therefore , those 30-50 accounts need to be resolved," Finance Minister Arun Jaitley had said recently.
There are some who are not comfortable with a sector or size specific approach. "Only big people are given oxygen. That's not fair. This can also snowball into a political slugfest," warns a consultant. The approach should then be to look at deserving candidates.
"The first filter has to be the size (of loan). The other criterion should be operational projects or projects that can be made operational in a short period of time. We should also have another filter to look at projects where additional money is required to complete the project," advises Bahuguna.
There are other issues as well. "Pricing is a big issue. The problem with the power sector is actually low tariffs. In case of infrastructure, the pricing is wrong. We want world class infrastructure at zero cost," says Chakrabarty. Some say there are many broken pieces in the system like cancelled telecom and coal licenses, which cannot be fixed.
Another radical idea, often discussed in banking circles, is allowing large public sector units such as SAIL and NTPC to buy some of the large assets. But experts say, given the current challenging environment, it is not the right time to burden the PSUs. Steel major SAIL has been making losses in the past 18 months. Khandelwal says this can be experimented selectively by PSUs who have strong balance sheets and have past track record of transformational turnaround of their own enterprises. But some experts believe that such a merger will also have integration challenges in terms of work culture, policies, compensation, etc.
Existing Resolution Tools
Some expert suggest there are enough tools available currently like SDR, S4A, 5/25 and CDR. There is a need to plug the gaps like having more oversight committees to decide the haircut, a leaner joint lenders forum (JLF) for faster decision making etc. The bankers, however, complain that there is no one size that fits all. The various resolution mechanisms haven't been successful. The SDR has been a complete failure while S4A requires conversion of debt into equity without changing the management.
There is also a move to strengthen the wilful default mechanism. Legal experts say the guidelines are adequate but they are not effectively used by the banks. The banks have been using them as arm twisting tactics. They invoke wilful default guidelines even in cases where long term funds are used for short term and vice-a-versa. In many instances, the courts have rejected the banks case for a wilful default. In fact, there is also no coordination among banks when declaring a promoter or director a wilful defaulter. "The banks have to beef up their anti-fraud systems and also forensic skills to make a full proof case against defaulters," says a lawyer. Khandelwal says the guidelines are adequate and sufficient enough. " Failures experienced by banks in court cases are primarily due to lapses on the part of the banks in following the due process of declaring any company or directors as wilful defaulters," says Khandelwal.
Two years ago , the Calcutta High Court had set aside the United Bank of India's decision to declare defunct Kingfisher Airlines and its directors as willful defaulters. The High Court had ruled that the grievance redressal committee was not formed as stated in the guidelines. Chakrabarty has another reservation about the existing guidelines. "Nowhere in the world is there a distinction between wilful and non wilful defaulter," he says.
Twin Balance Sheet Problem Today, banks are operating in a much more transparent environment. In the past, banks have taken a long time to detect loans becoming NPAs - either deliberately or because of their own ignorance - and this has to change. In order to have coordination among banks, the RBI has also created a database of large loans accessible to all banks to take corrective action. "Going forward, the banks will have to play a dual role in corporate banking in terms of being the provider of both capital and sound advice. The banks as lender will likely be heard by the enterprise," says Piyush Singh, Accenture Financial Services India.
Solution Lies Within
Despite the new models , the basic principles of restructuring cannot change. "There is a need for banks to take deep haircuts. There is a need for a turnaround strategy for every business. The whole culture or mindset of turnaround is not there," says Abizer Diwanji, Partner and National Leader at EY. There is also a cost (attached to bad loans). If one takes gross NPAs of Rs 7.35 lakh crore, the cost of funds to banks (at 5-6 per cent ) alone would be Rs 40,000 crore. The earning loss to banks would be Rs 73 ,500 crore. As against this, the recovery every year is less than Rs 22,000 crore. "The recovery has to keep pace with the cost or earning otherwise the stress would gradually make the system inefficient," says a private banker. Ultimately, the solution to the bad loan problem lies within."In our system , there is no concept of accountability. The banks have to improve governance, build good risk management practices, hire quality people and inculcate the system of accountability. We have to hold people accountable for lapses. How many banks' board have been superseded because of high NPAs?" says Chakrabarty.
Private sector HDFC Bank with the lowest NPAs in the banking system is a good example of sound credit and risk management. The government has taken the first step by setting up BBB which should percolate down . "All possible steps are being taken to improve the leadership bench strength and improve the overall governance standards in the areas of credit and risk management," says Khandelwal.
RBI Deputy Governor N. S. Viswanathan recently gave a good football analogy to explain the basic framework of a robust bank lending system. The loan officers are the first line of defense, the credit risk officer the second and the internal audit is the third. The board and the senior management are like the coach and manager of a team.
That's a winning formula. And at this stage of the bad loan game, time is actually running out for banks.