The op­tions be­fore the gov­ern­ment to re­solve the ` 14 LAKH CRORE NPAs and stressed loans

Business Today - - FRONT PAGE - By Anand Ad­hikari

Two decades ago, the Malaysian bank­ing sys­tem was on the verge of collapse when a cur­rency crisis en­gulfed sev­eral Asian coun­tries. The bad loan sit­u­a­tion was alarm­ing, very sim­i­lar to the sit­u­a­tion in In­dia to­day, and its non per­form­ing as­sets (NPAs) jumped from 2-3 per cent to dou­ble dig­its in a mater of four-five years. Malaysia had ex­pe­ri­enced a high growth of 9 per cent plus for a decade lead­ing to the cur­rency crisis in 1997. The Malaysian gov­ern­ment re­acted fast by set­ting up tow as­set man­age­ment com­pa­nies (AMCs) – one to take over bad loans named ‘Dana­harta’ with spe­cial pow­ers and

an­other for in­fus­ing cap­i­tal into the weak banks called ‘Danamodal’. About seven years later, both the AMCS shut shop as the mis­sion was ac­com­plished.

More re­cently, China, which has a largely opaque bank­ing sys­tem, has turned cre­ative by start­ing a mas­sive se­cu­ri­ti­sa­tion drive to sell stressed loans by bundling them as mar­ketable se­cu­ri­ties. Half a dozen Chi­nese banks have tested the mar­ket by of­fer­ing such se­cu­ri­tised loans at a dis­count to in­vestors. Glob­ally , there is enough in­vestors ap­petite for such high risk, high re­turn junk pa­pers. China, which is cur­rently bat­tling its big­gest slow­down af­ter record­ing near dou­ble digit growth for two decades , has bad loans cross­ing $5.5 tril­lion. Many global experts be­lieve that the main­land has found a new way to deal with its mount­ing bad debt prob­lem.

There are nu­mer­ous ex­am­ples – from the Czech Repub­lic to Hun­gary, Ja­pan and the US – where the gov­ern­ments or the reg­u­la­tors have used cre­ative ways to deal with mount­ing bad loans. In­dia’s `75 lakh crore bank­ing sys­tem is grap­pling with a sim­i­lar prob­lem 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 `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.

K. C. Chakrabarty, for­mer deputy gov­er­nor at the Re­serve Bank of In­dia (RBI) paints a more alarm­ing pic­ture.

` 76,685 crore is the wil­ful de­fault amount 75-80 % of the stressed loans be­long to pub­lic sec­tor banks

30-35% of the stressed loans are in steel, power, min­ing and in­fra­struc­ture sec­tors

Gross NPAs are about ` 7.4 lakh crore Stressed loan of ` 14 lakh crore is equal to the com­bined as­sets of ICICI Bank & HDFC Bank

Ac­cord­ing to him, stressed loans in the sys­tem will not be less than `20 lakh crore. This in­cludes NBFCs, in­sur­ance com­pa­nies, co­op­er­a­tive banks and other non bank in­sti­tu­tions. “The sys­tem has also writ­ten off around `4 lakh crore. Do we count that money ?” asks Chakrabarty. The gov­ern­ment, the owner of pub­lic sec­tor banks, re­alises this. In the last two years , the RBI’S approach to stressed as­sets has been of a deep surgery than band aids. The as­set qual­ity re­view of stressed loans in the en­tire bank­ing sec­tor re­vealed the real pic­ture of NPAS in the sys­tem. Dur­ing the six quar­ters end­ing March 2017, the banks saw a huge dip in prof­itabil­ity and losses in some cases. While the gov­ern­ment has set up a bank­ruptcy code, the RBI has moved away from cor­po­rate debt re­struc­tur­ing (CDR) to schemes like Strate­gic Debt Restru­tur­ing ( SDR) where lend­ing banks can even throw the pro­mot­ers out.

In­deed, the gov­ern­ment and the RBI are work­ing in tan­dem to is­sue the next set of mea­sures to speed up res­o­lu­tion. There are talks of mak­ing a more flex­i­ble joint lenders’ fo­rum (JLF), by re­duc­ing the re­quire­ment of ap­proval from at least 75 per cent of the lenders – in value terms – to take a de­ci­sion to a much lower 51 per cent. This will re­sult in faster de­ci­sions on re­struc­tur­ing. In or­der to make hair­cuts eas­ier for banks, there is al­ready a pro­vi­sion of an over­sight com­mit­tee of in­de­pen­dent pro­fes­sion­als un­der S4A to take a de­ci­sion. But there is no such pro­vi­sion for other re­struc­tur­ing mech­a­nisms like SDR, 5/25, etc. The gov­ern­ment is now con­sid­er­ing set­ting up a panel headed by the cab­i­net sec­re­tary for tak­ing ‘hair­cut’ de­ci­sion in large cases or more over­sight com­mit­tees for SDR or 5/25. The gov­ern­ment is also con­sid­er­ing an in­sti­tu­tional mech­a­nism by mak­ing changes in the Preven­tion of Cor­rup­tion Act (PCA), a big hur­dle to­day as bank em­ploy­ees come un­der it. There is a fear of fu­ture in­ves­ti­ga­tion by agen­cies un­der the Act for any pro­fes­sional de­ci­sion gone wrong. Re­cently, the top of­fi­cials of IDBI Bank in­clud­ing its for­mer chair­man were ar­rested for al­legedly favour­ing Vi­jay Mallya’s now de­funct King­fisher Air­lines. The PCA to­day doesn’t make any dis­tinc­tion be­tween a flawed and a cor­rupt de­ci­sion. There is a move to amend the Act to pro­tect em­ploy­ees

when de­ci­sions are taken in a pro­fes­sional ca­pac­ity. Un­doubt­edly, there is a huge ac­cu­mu­la­tion of stressed loans in a very short pe­riod of time. “When you have such a mas­sive build up, there is no op­tion but to sell. In the cur­rent set-up, there are is­sues of skill, band­width and abil­ity to pre­serve present value,” be­lieves Vi­nayak Bahuguna , MD & CEO of the coun­try's first as­set re­con­struc­tion com­pany (ARC) ARCIL Ltd. The sit­u­a­tion is in­deed grim. Two stal­warts of the fi­nan­cial world also spoke their mind re­cently. K. V. Ka­math, who now heads the BRIC Bank, has warned that time is fast run­ning out while Deepak Parekh, Chair­man of HDFC Group, has talked about bit­ing the bul­let.


If global his­tory is any in­di­ca­tion, 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 `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,”

have The gross a low of jumped from in 2011/12 2.5 per cent 10 per cent to a high of in 2016/17

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.


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 undercapitalised to take hair­cuts. Some cite the UDAY power bond as a prece­dent where a bank's 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 `2 crore to `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 `10,000 crore, an ARC struc­ture may be best suited to han­dle it. Where the debt is very high, say `30,000 crore or `40,000 crore, ARCs may not be ready to­day," says Antony.


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 `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.

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 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 op-

er­a­tional 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.


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 bank's 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 an­tifraud 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.


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.

Mean­while, the RBI has al­ready started an ex­er­cise

to iden­tify weak bal­ance sheets based on higher gross NPAS and re­struc­tured loans. Re­cently, the RBI has put some re­stric­tions on few banks which have very weak bal­ance sheets. ( See The Par­al­lel Approach). The idea is to tackle the bad loan prob­lem from both ends – the com­pany as well as lend­ing in­sti­tu­tion.

A weak bal­ance sheet is­sue also makes a case for merger in the PSB space. The RBI has now come out with a new frame­work for trig­ger­ing a merger of weak banks. The weak banks would be iden­ti­fied based on fall­ing cap­i­tal ad­e­quacy ra­tio, higher NPAS, lower prof­itabil­ity and higher lever­age. For ex­am­ple, Chen­nai- based In­dian Over­seas Bank has seen its gross NPAs ris­ing to an alarm­ing level of 22 per cent. This loss mak­ing bank has a cap­i­tal ad­e­quacy of 10.42 per cent , which is in the dan­ger of ab­sorb­ing the pro­vi­sion­ing shocks. In case there is a sub­stan­tial de­te­ri­o­ra­tion , there could be some se­vere ac­tion from the RBI. There are half a dozen other PSBS mir­ror­ing sim­i­lar trends. There is al­ready talk of cre­at­ing five-six large banks by merg­ing the 27-odd PSBS. Most of these banks are mir­ror im­ages of each other when it comes to ser­vice cul­ture, prod­uct bas­ket, peo­ple , etc. The larger bank with man­age­ment band­width will be in a bet­ter po­si­tion to tackle the bad loan prob­lem.

The banks now have a good le­gal frame­work, in terms of the Bank­ruptcy Code, to deal with the prob­lem. The good part about the sys­tem is that it is not just de­pen­dent on the banks. Cur­rently, an SDR and S4A are avail­able for In­dian banks. The Bank­ruptcy Code is for ev­ery­one in­clud­ing for­eign lenders. So non–bank lenders can also trig­ger an SDR or S4A.

“The Bank­ruptcy Code will en­cour­age faster de­ci­sion mak­ing for all the stake­hold­ers. The banks have to be pre­pared to de­cide very quickly (on re­struc­tur­ing). If a non bank player in­vokes it, the banks will be forced to come to the ta­ble,” says Bahuguna. Bank­ruptcy won’t work if the debt is not ag­gre­gated and you have only six months to get the work done, points out Siby Antony of Edel­weiss.


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 `7.35 lakh crore, the cost of funds to banks (at 5-6 per cent ) alone would be `40,000 crore. The earn­ing loss to banks would be `73 ,500 crore. As against this, the re­cov­ery every year is less than `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. ~

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