Judiciary to the rescue of banks?

India’s banks, wilting under the heat turned on by Reserve Bank of India’s (RBI’s) February 12 resolution framework for non-performing assets (NPAs), may well end up getting relief from the courts.

The Allahabad High Court has stayed the operation of the framework for the power sector except in cases of wilful defaulters. The court has also directed the finance ministry to meet all stakeholders and see if a resolution outside the framework is possible. The order came in response to a writ petition filed by the Independent Power Producers Association of India (IPPAI). The All India Bank Officers’ Confederation (AIBOC), which represents 300,000 public sector employees, has moved a writ petition in the Delhi High Court asking for the RBI’s resolution framework to be quashed in toto.

You could have seen this coming. For the past three months, the government, banks and corporate borrowers have been pleading with the RBI to relax the norms laid down in its resolution framework, especially in respect of infrastructure projects. The RBI has refused to budge.

Rigidly adhering to the resolution framework means more than another round of crippling provisions for banks. It also means that billions of assets will head for the National Company Law Tribunal (NCLT). Many of the infrastructure projects are unlikely to find bidders in today’s situation. The outcome will be liquidation of painfully built infrastructure assets and poor recoveries for banks.

Already, 11 public sector banks (PSBs) are under the RBI’s Prompt Corrective Action (PCA) scheme whereby they are subject to various restrictions. Some of the banks have been asked to shrink their balance sheets. If power and other infrastructure assets are dealt with under the RBI’s resolution framework, we face the prospect of more banks coming under PCA and a further shrinkage of PSB balance sheets.

This hardly seems a sensible way of dealing with the banking problem. Shrinking of PSB balance sheets will have a negative, multiplier effect on the economy. Borrowers at the shrinking banks will be adversely impacted. This, in turn, will impact the relatively stronger banks to whom the borrowers may be exposed. As more banks are impacted, so will more borrowers. It is unrealistic to expect financial markets, Non-Banking Financial Companies (NBFCs) and private banks to pick up the entire slack in credit. The RBI’s resolution framework poses serious risks to the economy over the medium-term.

The framework needs to be reworked. The time frame for resolution must be extended from 180 days to one year. There is also a case for treating power and infrastructure projects differently from other assets. A couple of proposals that are on the table are worth considering.

Under one proposal, stressed assets in the power sector worth nearly ~750 billion would be taken over by a consortium of lenders and housed in an Asset Management and Revitalisation Company (AMRC), which will be substantially owned by the lenders themselves.

This is a different concept from an Asset Reconstruction Company (ARC) to which banks sell their loans at a discount. In the proposal under review, lenders will take over power sector assets using shares of over 51 per cent of the total equity that promoters have pledged to them. The stressed assets will be transferred to the AMRC at their net asset value (book value less provisions). The AMRC will pay for the assets entirely through Security Receipts. As there is no hair-cut, no infusion of capital into the lenders is required. The lenders will continue to make provisions for NPAs as per RBI norms.

The AMRC, which would have experts from NTPC Ltd and other PSUs, would nurse the assets back to health by addressing gaps such as fuel linkages and PPAs. Once the assets are restored to health, they could be sold to state-owned generation companies and private parties. This approach not only preserves valuable infrastructure assets, it has the potential to result in better recoveries for lenders.

Under another proposal mooted by the State Bank of India (called “Samadhan”), the debt would be broken up into sustainable and unsustainable parts with the help of rating agencies. The unsustainable part would be converted into equity and a 51 per cent stake offered to bidders while the remaining equity would be held by lenders until better times return.

Both proposals entail a departure from the RBI’s resolution framework. They reflect the perception amongst bankers that the NCLT must not become the default option for banks. The RBI is averse to measures that involve any kicking of the can down the road. However, as any good banker knows, some kicking of the can is integral to banking. If we need the courts to get the RBI to recognise this and effect a change of course, so be it.