Loan restructuring: This time is different
It marks a reversal in the approach to tackling bad loans, but it is not kicking the can down the road
India’s banking sector appears unable to shake off its jinx. Years of improvement in performance tend to get erased by some exogenous shock or the other.
The sector started off the post-reform phase with a ratio of gross non-performing assets (NPAS) to loans of 16.0 per cent in 1996-97, a number worth bearing in mind when analysts portray the banking sector today in apocalyptic terms. Rapid economic growth and the reforms undertaken at public sector banks (PSBS) helped the sector recover solidly. A decade later, in 2007, the NPA level had come down to 2.6 per cent.
Then the global financial crisis struck. This was followed by a string of adverse court judgments relating to various sectors of the economy and the Asset Quality Review. By 2017-18, the NPA level had risen to 11 per cent, an indicator of a banking crisis.
A determined effort at recognition and resolution brought the NPA level down to 8.5 per cent by 2019-20. The pandemic has dealt a severe setback, with NPAS threatening to rise to 12.5-14.7 per cent, according to the Reserve Bank of India’s (RBI’S) Financial Stability Report of July 2020.
The latest attempt at loan restructuring is an attempt to stave off these dire possibilities. It marks a reversal in the broad approach to tackling bad loans. Before the onset of the pandemic, the focus was on recognising bad loans, resolving them through the Insolvency and Bankruptcy Code (IBC) process and recapitalising banks as required. In that period, “kicking the can down the road” became almost a pejorative expression.
After Shaktikanta Das took over as governor, the RBI’S approach began to change. In January 2019, the RBI announced a one-time restructuring scheme for micro, small and medium enterprises (MSME) valid until March 31, 2020. The scheme was later extended up to December 31, 2020.
Following the pandemic, the IBC process was suspended for a year. Bank-led restructuring is back with a bang under a new plan unveiled last August by the RBI as a window under the June 7, 2019 guidelines for restructuring (which is a revised version of the February 24, 2018 circular struck down by the Supreme Court).
The August scheme comes with several checks. It is intended only for firms affected by the pandemic and will be applicable to firms not in default for more than 30 days prior to the cut-off date of March 31, 2020. All proposals above ~100 crore will require validation by an independent agency. Proposals above ~1,500 crore will be vetted by the K V Kamath committee appointed by the RBI.
Loan tenures cannot be extended by more than two years under the resolution framework. Banks will have to decide which accounts are eligible for resolution by December 31, 2020. Individual and MSME loans will have to be resolved by March 31, 2021 and corporate loans by June 30, 2021. The Kamath committee has specified parameters that resolution plans must adhere to 26 sectors.
Sceptics says that, despite these checks, the latest resolution plan will go the way of earlier ones. They overlook two crucial differences in the present situation. First, the provision coverage ratio (PCR) at banks has gone up considerably in recent years — from 48 per cent in 2018 to 65 per cent in 2020. At some PSBS, the PCR today is pretty high: 82 per cent at the State Bank of India and 81 per cent at Bank of Baroda. That is one factor that diminishes banks’ motivation to kick the can down the road.
Secondly, after the experience with loan restructuring on the last occasion, the market will take a dim view of banks that have a high proportion of restructured loans on their books. This again reduces incentives to dress up accounts. Banks that don’t want their valuations hammered will think it prudent to keep restructured loans at under 5 per cent of their loan book.
How quickly the economy recovers has a crucial bearing on any restructuring that is attempted. Following the fall in India’s GDP by 23.9 per cent in the first quarter of 2020-21, most analysts have been quick to conclude that the decline in GDP for the year as a whole would be in double digits. It’s possible that the gloom is overdone.
The August report on the economy by the Department of Economic Affairs indicates that the recovery may be stronger than thought earlier. In a recent paper, C Rangarajan and D K Srivastava suggest that a modest positive growth in the economy is possible even in 2020-21. (“India’s growth prospects and policy options: emerging from the Pandemic’s shadow”, Indian Public Policy Review, August 2020). We don’t quite know whether GDP will rise above the pre-pandemic level in 2021-22 or 2022-23.
How to judge the extent of restructuring required? One approach would be to not rush resolution plans, except for borrowers for whom default is imminent. Another would be to put in place agreements with borrowers that have an upside to repayments if recovery turns out to be stronger than forecast in the plans.
The matter of interest charged on loans during the moratorium period, which is pending before the Supreme Court, will have a bearing on loan restructuring. Borrowers want the interest during the moratorium period to be waived, not added to the principal outstanding at the end of the sixmonth moratorium period.
During the hearings, the Indian Banks’ Association has reportedly offered a two-month moratorium on declaring any account as NPA at the end of the moratorium period on August 31. If accepted, it would mean an extension of the time period for declaring an account as NPA from 90 days to 150 days under the aegis of the court.
Whatever the outcome, there is an important lesson in political economy here. The RBI has, in recent years, set its face against any dilution of regulatory norms, including the NPA norms. Politicians are faulted for leaning on the RBI to practise regulatory forbearance. Perhaps, it is time to recognise that, in matters of regulation, the larger system will have a say one way or another.