Tackling Bad Debts
The huge pile of non-performing assets (NPAs), or bad loans, on the account books of state-owned banks has undermined their health in more ways than one. Aside from the delayed/ nonrepayment, NPAs also hit the profitability of banks because they are required to make provisions (put aside a certain percentage of the outstanding amount) to insure themselves against defaults, reducing the funds available for new loans. In this regard, the new Insolvency and Bankruptcy Code, 2016, though touted as a clean-up of the banking sector, has made life even worse.
When a defaulter is referred for insolvency, negotiations usually end with the lender agreeing to take a ‘haircut’ on the amount to be repaid—settling for less than what was originally owed. This puts lenders at a further disadvantage, since they have to make new provisions for these ‘haircuts’.
“How will banks withstand the losses [from insolvency resolutions] and yet have
enough of a capital buffer to [protect] the huge proportion of the economy’s savings that they receive as deposits?” asks Viral Acharya, deputy governor, RBI. Crisil, a ratings agency, estimates that banks may have to take a haircut of 60 per cent, about Rs 2.4 lakh crore, to settle 50 large NPAs totalling Rs 4 lakh crore. These 50 loans were made to companies in the metals, construction and power sectors, and account for half the total NPAs in the banking system. “[NPAs of] Companies from the power sector would require moderate haircuts, while those from the metals and construction sectors would need [more severe] ones,” says Pawan Agrawal, chief analytical officer, Crisil.
RBI governor Urjit Patel has called for a recapitalisation of staterun banks as they are not financially strong enough to take severe ‘haircuts’. According to sources, this is already in the works—the government has allocated Rs 10,000 crore for 2017-18 on this account, over the Rs 25,000 crore already allocated over the past two fiscals.
Finance minister Arun Jaitley recently conceded that recovering money from large defaulters is a “major challenge”. The recovery of NPAs via insolvency proceedings will also likely be challenged in the courts—as has happened in the case of Essar Steel—further delaying this urgent process.