Spring Clean­ing for Banks

Pro­fes­sional man­age­ment, strong bank­ruptcy law and a bub­bly bonds mar­ket will strengthen the lenders

The Economic Times - - The Edit Page - Nikhil Arora

RBI’s 2015 Fi­nan­cial Sta­bil­ity Re­port pro­vides a clear pic­ture of In­dian banks’ de­te­ri­o­rat­ing asset qual­ity. As in Septem­ber 2015, 14.1% of to­tal loans han­dled by pub­lic sec­tor banks (PSBs) are stressed. Less than half of them are clas­si­fied as non-per­form­ing as­sets (NPAs) and the rest as ‘re­struc­tured’. Share of the stressed loans has tripled since 2009, with medium and large cor­po­rate bor­row­ers con­sti­tut­ing a lion’s share of dis­tressed coun­ter­par­ties.

The on­go­ing bad debt de­ba­cle isn’t merely about fail­ure in risk man­age­ment or ques­tion­able cor­po­rate ethics. It also high­lights the un­fair­ness of our fi­nan­cial and le­gal sys­tem. How can In­dia’s lead­ing PSBs man­age to hu­mil­i­ate de­fault­ing stu­dents by post­ing their pic­tures, but are un­able to re­cover their debt from an air­line com­pany af­ter more than 500 court hear­ings?

Apart from the eco­nomic slow­down, wil­ful de­fault, di­ver­sion of funds by bor­row­ers, lapses in governance of PSBs, and wide in­ef­fi­cien­cies in bank­ruptcy laws are re­spon­si­ble for these bad debts. The gov­ern­ment has been work­ing on mul­ti­ple fronts to tackle these ar­eas.

The seven-point In­drad­hanush pro­gramme, in­tro­duced in Au­gust 2015, forms the prin­ci­pal ac­tion plan so far. Its high­light is its re­cap­i­tal­i­sa­tion plan of .₹ 70,000 crore (to be in­jected till 2018-19) into ma­jor PSBs. The pro­gramme in­cludes rec­om­men­da­tions to im­prove the governance pro­cesses within PSBs by sep­a­rat­ing the po­si­tions of the non-ex­ec­u­tive chair­man and man­ag­ing di­rec­tor, and the set­ting up of an over­ar­ch­ing ‘in­de­pen­dent’ Banks Board Bu­reau (BBB) to act as a buf­fer be­tween the gov­ern­ment and man­age­ment, and take the role of an ap­point­ments board for all PSBs to choose their di­rec­tors and non-ex­ec­u­tive chair­men.

The idea is to min­imise pos­si­ble in­ter­fer­ence from the gov­ern­ment, pro­mote trans­parency and re­view the busi­ness mod­els of PSBs to op­er­ate them as pri­vate en­ter­prises. But the plan lacks de­tail on many fronts. Another area of on­go­ing dis­cus­sion con­cerns bank­ruptcy re­forms.

The Insolvency & Bank­ruptcy Bill was in­tro­duced in Lok Sabha in De­cem­ber 2015. Insolvency is cur­rently driven by var­i­ous laws and agen­cies with over­lap­ping ju­ris­dic­tions, re­sult­ing in low re­cov­er­ies and long de­lays. In­dia is ranked136 (out of 189 coun­tries) in re­solv­ing insolvency by the World Bank, with av­er­age pro­ceed­ings last­ing 4.3 years and av­er­age re­cov­ery of just 26 cents to a dol­lar.

BankingonBankrupt­cyLaw

This Bill rep­re­sents the first at­tempt to have a uni­form bank­ruptcy law in In­dia. The pro­posal in­cludes the set­ting up of an insolvency reg­u­la­tor, sep­a­rat­ing tri­bunals for un­lim­ited and lim­ited li­a­bil­ity firms, util­is­ing insolvency pro­fes­sion­als to de­velop best prac­tices, build­ing a com­pre­hen­sive insolvency data­base, and a clear lay­out for both res­o­lu­tion and liq­ui­da­tion within 180/270 days. A tran­si­tional pro­gramme to fill the gaps be­tween the legislation and im­ple­men­ta­tion is as im­por­tant as the legislation it­self.

The new insolvency reg­u­la­tor should ideally be cre­ated by the time the law is passed. An in­terim reg­u­la­tor would only di­lute the ef­fec­tive­ness of en­force­ment. Sim­i­larly, the Na­tional Com­pany Law Tri­bunal (NCLT) to over­see lim­ited li­a­bil­ity cases needs to be cre­ated. Al­ready, ex­ist­ing debt re­cov­ery tri­bunals re­quire realign­ment with in­creased re­sources and in­fra­struc­ture.

The gov­ern­ment’s in­ten­tions are in the right place. But a dis­con­nect among dif­fer­ent agen­cies is vis­i­ble. For in­stance, the RBI has set a dead­line of March 2017 to pro­vi­sion for all ex­ist­ing NPAs. The re­sult­ing pro­vi­sion charge and higher risk weights de­crease banks’ prof­itabil­ity and erode their cap­i­tal ra­tios. This de­te­ri­o­ra­tion is very vis­i­ble as per the lat­est RBI data and trans­lates into low share price per­for­mance and a deep dis­count in val­u­a­tion. Non-gov­ern­ment in­vestors would nat­u­rally sell off when the fun­da­men­tals of the bank are weak. So, it’s no sur­prise that many PSBs cur­rently trade be­low their book val­ues as com­pared to pri­vate sec­tor banks.

The RBI is keen on banks fac­ing the bad debt is­sue head-on. But with­out a co­or­di­nated strat­egy from the gov­ern­ment, this can pan out more as blunt force trauma in­stead of long-term re­form. Ex­pect­ing PSBs to suf­fer from re­duced prof­itabil­ity, val­u­a­tions and cap­i­tal con­straints with­out ad­e­quate fi­nan­cial sup­port is akin to climb­ing a moun­tain with one arm tied be­hind.

This is not an ar­gu­ment in favour of a higher cap­i­tal in­jec­tion on a sil­ver plat­ter. It should rather be treated as a bar­gain­ing chip for more fun­da­men­tal banking re­forms that cover governance, trans­parency and own­er­ship. It is also es­sen­tial to de-stress the sec­tor by pro­vid­ing cor­po­rate bor­row­ers with al­ter­nate sources of fund­ing. The devel­op­ment of a liq­uid and deep cor­po­rate bond mar­ket goes a long way in eas­ing that pres­sure.

Fi­nally, the devel­op­ment of a ro­bust cor­po­rate bond mar­ket will pro­vide op­tion­al­ity to bor­row­ers and al- low bank bal­ance-sheets to de-stress. Cur­rently, our bond mar­ket com­prises pri­mar­ily of gov­ern­ment se­cu­ri­ties. Cor­po­rate bor­row­ers, be­sides the large listed play­ers, gen­er­ally de­pend on bank loans for their fi­nanc­ing needs.

On the oc­ca­sion when they tap the bond mar­ket, it is usu­ally through pri­vate place­ments (95% of to­tal is­suances as in 2014-15) rather than pub­lic is­suances. The rea­son for this is the lack of a wide in­vestor base and ap­petite, in­suf­fi­cient trans­parency from is­suers, ab­sence of liq­uid price bench­marks, a non-func­tion­ing credit de­fault swaps (CDS) mar­ket to pro­vide pro­tec­tion, and no har­monised bank­ruptcy frame­work.

Glo­cal So­lu­tions

A com­pre­hen­sive re­view is es­sen­tial. Guide­lines pro­vided by RBI deputy gover­nor Harun R Khan fo­cus on stake­hold­ers and pro­vide well-de­fined thoughts on lib­er­al­is­ing in­vest­ment guide­lines for in­vestors, en­hanc­ing in­cen­tives for is­suers, and im­prove­ment in in­fra­struc­ture.

Many big pri­vate sec­tor banks in the western world failed spec­tac­u­larly dur­ing the fi­nan­cial crisis. It is, there­fore, es­sen­tial to ques­tion those mod­els as well, in­stead of treat­ing them as a magic fix. We have to ap­pre­ci­ate the his­tor­i­cal ba­sis of our own sys­tem and find holis­tic so­lu­tions that are fair and pru­dent. This will only add ro­bust­ness and longevity to our growth story.

Count­ing on a bet­ter ser­vice

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