Spring Cleaning for Banks
Professional management, strong bankruptcy law and a bubbly bonds market will strengthen the lenders
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.
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.
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.
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