THE REFORMS BLUEPRINT
The latest 11-point government plan to head off the crisis in India’s banking sector came out of a ‘PSB manthan’ of whole-time directors of public sector banks and senior executives in November 2017
1 Ensure that loan approvals are based on rigorous due diligence
Banks do already have due diligence processes, but the scale of the NPA problem proves these were not being followed. A finance ministry analysis revealed highway projects in which loans were disbursed before environmental clearances had been granted and power projects that began work without knowing who would supply the coal or buy the electricity. Projects with incomplete business plans are almost certain to face difficulties during repayment. 2
Ensure that borrower’s balance sheets are scrutinised and cash flows are appropriately ring-fenced
Finance ministry officials say in many cases banks did not have the expertise to properly examine borrower paperwork, failing to identify artificial leveraging and over-invoicing, such as is alleged in the case of Essar Projects, currently with the National Companies Law Tribunal (NCLT). Ring-fencing borrower cash flows might help—funds granted for a specific project will be monitored to ensure they are not diverted to other uses.
3 Take note of non-fund and tail risks embedded in project financing
Non-fund risks apply to bank guarantees and letters of credit. Nirav Modi’s fraud depended heavily on paperwork like this, using bank guarantees from one bank to take loans from another. Tail risk applies to projects that take a significant amount of time to complete. In such cases, the ‘finishing’ stage is usually when cost and time overruns/ missing permits become outright liabilities. Banks need to estimate the risk (and cost) of such overruns, budget accordingly.
4 Increase the use of technology and analytics for comprehensive due diligence across multiple regulatory databanks
In the same way that CIBIL maintains credit reports on individual borrowers, industry boards maintain reports on companies in their field. Cross-verification of information given by loan applicants from these databases would add an extra layer of certainty to decision-making, and might even help banks identify corporate borrowers who are hiding relevant information. According to the finance ministry, this applies to Reliance Communications, which neglected to inform banks that it had taken significant loans from Chinese lenders. This was both illegal and could not have happened without the connivance of bank officials.
5 Lead banks in a consortium must build capacities for techno-economic valuation. Secondary banks to help via validation or assessment
Banks have shown a very poor capacity to assess and monitor risk. The projects being attempted today often depend on a great deal of technical knowledge and domain expertise, which is also essential to valuing them and assessing their risks. If a bank cannot fully comprehend the technical scope of a project, it cannot accurately estimate associated risks and costs.
6 Loans over Rs 250 crore to be monitored by banks (with help from experts) after disbursement. Banks in a consortium to share information, ensure all are on the same page.
This partially relates to the point regarding techno-economic valuation. Until now, there has been no special-
ised monitoring of big loans, especially by outside parties. Bankers, however, are contesting this point, asking what is their role if third parties are to be involved in monitoring loans.
7 A consortium will only have nine banks, with each bank contributing a minimum of 10 per cent of the total loan
It has been observed that defaulters tend to clear the smaller dues to banks in a consortium while delaying payment of the largest chunk, in order to get relief by claiming some dues have been cleared. Smaller consortiums will also be easier to manage, and with each bank having a clear and equal stake, due diligence should improve.
8 A standard online procedure for valuation in consortium loans, to align periodicity and valuation methods, so that all members have access to the information
Finance ministry officials say Indian banks (even those that issue loans in a consortium) sometimes didn’t have procedures for information sharing about delayed payments. This is standard practice internationally.
9 An approved policy for strict segregation of loans and assignment of responsibilities for appraisal, monitoring and recovery
In many banks, loan procedures were found to be one or two-man jobs, which left a great deal of scope for collusion/ corruption, and also contributed to a lack of appropriate loan monitoring.
10 Changes in the Insolvency and Bankruptcy Code to ensure that NPA account holders cannot re-purchase their companies during bankruptcy proceedings
This ensures there is a clear cost to promoters who are responsible for NPAs, and also that they cannot benefit by buying back bankrupt firms for pennies on the dollar.
11 The RBI has been authorised to directly refer NPA cases to the NCLT
In the past, the fact that the RBI did not have this power meant that companies it had already determined were unfit/ loan defaulters could delay the process via political intervention.