New Banking Ordinance: What will be the Impact?

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TOPIC:General Studies 2

• Government policies and interventions for development in various sectors and issues arising out of their design and implementation.

The President approved an ordinance on NPAsby adding sections 35AA and 35AB to the Banking Regulation Act, 1949 (BRA) which will provide greater powers to the RBI to tackle mounting bad loans.The amendment is expected to help in effectively resolving the bad loans problems as the banks are struggling with the bad loans worth nearly Rs. 7 lakh crores.

Former RBI governor RaghuramRajan had initiated the process of Asset Quality Review in 2015 to recognise the bad loans within a deadline to clean up their balance sheets by March 2017. But the problem continues to plague the economy.

What the government thinks

The government’s diagnosis of the problem is that there are large number of NPAs, probably mainly in the PSBs. Most of the problems lies with regard to recovery is on account of issues in real sector and not wilful defaulters. The banks are not able to take decisions which normally bankers should take in such situation of taking a haircut, settling the account and moving forward or taking over the asset and going for liquidation.

The government’s diagnosis seems to be that the top management of the bank seems to be too risk averse and are not taking needed decisions and that is why NPAs continue to remain on the books of banks. So the government thinks that by bringing RBI into picture and enabling it to give directions to these banks to settle their accounts, set up committees to give buffer for decision making can solve the problem.

But it raises questions such as-

It is a problem of PSB and bringing in central bank to do operational issues is not apt. The NPAs are created by the decisions of banks and not RBI. To bring a regulator in this matter to give directions to the banks is a backseat management by RBI which is not beneficial in the long run. If the regulation is confined to PSBs then government should have done the work itself without brining RBI. If the buffers are provided to management of PSBs, they are going to be even more risk averse in future. So it is not known if it is really going to solve the problem.

Understanding the ordinance

The ordinance does not clarify the purpose of the amendment. Ideally a new law should have rationale and background so that there is no ambiguity in understanding the issue. But the amendment fails to give such resourceful insight. For instance, BRA already gives RBI expansive powers to issue directions to banks. Yet an amendment was made to give powers to the RBI that it already has.

The direction of reforms in the financial sector and the overall interconnectedness between the public and the private balance sheets is to put the regulator and the owners at the arm’s length.

While the contours of the agreement are yet to be made public, it also seems that CPSEs will be asked to take over some of the assets. This is some kind of nationalisation which raises questions.RBI is getting into a role of micro- manager which is not its role.

It is also said that Joint Lenders Forum will be given direction by the RBI. If 20 banks have financed one large project and they cannot come to consensus because of interference of one part of lenders’ segment with the promoters, it is not a good thing with RBI also interfering it.

Some kind of flexibility is expected to be given to existing frameworks like 5/25 scheme, JLF, S4A process etc. This was what the bankers are demanding despite the criticism that more flexibilities give promoters chance to get out with lesser penalties.

Not solving the past

In past 3-4 years, there was a same kind of anticipation about resolving of the NPA issues through various new schemes, which is visible today.

There is an attempt to distribute, diversify, take controversial decisions like price at which these assets have to be offloaded (haircut or discount at which banks should do it) etc.

However, not great efforts have been given in resolving the assets as it is mostly about restructuring.

Two types of NPAs- wilful defaulters who have diverted the money for other businesses and assets. There is a well thought out system to deal with wilful defaulters.

This ordnance doesn’t seek to deal with these defaulters.

The other set of NPAs which appear to have a larger proportion today have been caused by problems in the real sector which may be because of global economy, policy impediments, policy risks, some judicial decisions on environmental issues where projects were started and environmental concerns rose up later. These problems of NPAs arising out of policy impediments will be tackled through this ordinance.

NPAs got created because of lot of reasons- decision couldn’t be taken to solve it, off take for certain commodities like power is not upto the level, investing money from one source to another to revive the stressed assets. This in turn harms other projects and this has led to more powers to RBI.

This looks like a desperate solution to desperate situation. So far omnipotent solutions were being applied to borrowers in general. This attempts to take specific cases and try and reach a solution. As case by case flexibility has to be shown in overall regulatory. But RBI hardly has the expertise to make the commercial decisions or be part of it. They are a regulator and they supervise the banks. Their role and credibility will come to question if they take roles of directing banks to provide x amount of haircut in y case and similar things. The reputational hit taken by RBI due to demonetisation will be worsened with another body blow.

There is no need of RBI as an independent regulator to take over the NPA issues when already there have been independent bodies, quasi-judicial bodies, committees have been made to resolve the issue.

In conclusion

There has been mis-judgement and mis-handling of the NPAs since long. Mis-judgement meaning in 2013-14 because of non-tradeable sector, exposure to the exchange rate and large correction automatically inflated the debt which was incurred in foreign currency. The whole issue has been discussed publicly and when such happens, then there is increase in risk aversion.So any decision subsequently of each individual instance is also bound to be discussed publicly.

The focus has been the belief in the public and in general has been fostered that all the bad loans represent malfeasance. But for this, one has to go back to 2009-10 when the lending norms to infrastructural projects were relaxed by RBI. So banks were encouraged then as there was a financial crisis and external demand was out and therefore the reliance was only on domestic demand. This context is buried and is not discussed at all.

In 2009-10, every institution, including IMF had forecast a very over-optimistic picture. However, with slow growth of global economy and various other factors affecting it, the growth rate of India was also concurrently corrected. This does not mean that the funding made available for assets creation during those time are now malmalfeasance. It is necessary to look into the background to assess the present situation.

Restructuring schemes

5/25

• Allows banks to extend long-term loans of 20-25 years to match the cash flow of projects, while refinancing them every five or seven years.
• Until now, banks were typically not lending beyond 10-12 years. As a result, cash flows of infrastructure firms were stretched as they tried to meet shorter repayment schedules.

JLF

• JLFs were intended to recognize stressed assets early and come up with a corrective action plan (CAP) within 45 days.
• The system, however, did not work seamlessly as there were disagreements between lenders on how to move forward on individual accounts.

S4A

• Large ticket loans are restructured by separating a sustainable loan from an unsustainable loan. The lenders make the classification.
• Sustainable level of debt is one which the banks think the stressed borrower can service with its current cash flows.
• Banks can convert the unsustainable debt into equity or equity related instruments, which are expected to provide upside to the lenders in case the borrower cannot regain the glory and rework the financial structure.

How NPAs are created?

Giving a loan to a borrower is a commercial decision of the bank. The corporate borrower maybe unable to repay the loan for any number of reasons. Lending decisions taken by an honest banker can also give rise to NPAs. The problem turns into a crisis when the NPAs are allowed to linger on for years and their volume become so large that banks’ balance sheets become severely impaired. This eventually leads to a credit crunch in the economy and starts to affect investment and growth, as has been the case over the last few years in the Indian economy. (Source: Wire)

Connecting the dots:

• Indian banks need to resolve their NPA issues at the earliest to boost the economy for further development. What are the measures taken by concerned stakeholders to address the issue?