From no norms to calibrated toughening and tightening of screws, it has been a long journey for NPA guidelines. But the new resolution diktat of the RBI is creating a furore, not because norms have changed (they still remain 90 days), but because of the accelerated provisioning and aggressive timelines for resolution.

For NPAs, it means an orderly march to the graveyard that is the Insolvency and Bankruptcy Code (IBC). For banks, it means a definitive end to kicking the can down the road.

It is hard to blame the regulator, which has to juggle the conflicting objectives of managing systemic risk and the financial health of banks. The financial implications for banks are obvious, but what should concern us more are the questions that it throws up on bank financing and corporate investment.

Liquidity matching

The problem is accentuated in India because we have a bank-dominated financial system. Banks are the major channel for both savings and borrowings, leading to the classic liquidity-matching problem, with banks needing to balance long-term lending to corporates with the short-term nature of their deposits. Not only does this limit loan tenors, but also their ability to restructure debt.

What helped banks in the past were not just the absence of NPA norms (they came into being only in the mid-1990s), but the steady flow of deposits, which more than covered up the hole that the bad loans created in cash flows.

Depositors seemed unperturbed about non-performance because of the implicit guarantee of the government, while corporates preferred bank borrowings because of the lesser disclosures involved, lenient delinquency laws and lax enforcement, unlike equity.

Much of these has now changed, which is the cause of the current pain points — with stricter NPA norms, banks are reluctant to lend or endlessly restructure corporate debt, while the new IBC poses a serious threat to errant promoters.

The wrong way

Interestingly, if banks, borrowers and even the government are lately complaining about the harshness of the new norms, it is a tacit admission that bank loans are not the best way to finance corporate investment.

Given the nature of their business, banks have no escape from adhering to fair valuation and capital-adequacy norms, while equally, banks and borrowers also feel the pain of a mechanical application of norms.

There is thus a clear rationale for moving to market-based borrowing. But we know too well why we don’t have a developed debt market — the lack of breadth in participation (the government is the largest borrower while public sector banks are the largest subscribers), investor preference to hold to maturity (to avoid interest-rate risk), and institutional hurdles (stamp duty, taxes) are some factors. But perhaps the lack of a reliable yield curve that could be used to price risk, is even more significant.

How will non-performance play out in a market system? If banks were to subscribe to debt instruments of corporates, little would change, given that the NPA guidelines on investments will still kick in. But for other institutional investors, non-performance will mean a write down in the market value of their securities.

With rating agencies replacing banks as evaluators, the greater transparency implicit in credit appraisal should keep dubious borrowers away.

Together with the development of reliable interest-rate benchmarks, the weaning away of corporates from banks to markets can be a big first step in addressing the bad loans problem of banks.

But for borrowers, a transition to market discipline could be a mixed experience — top corporates in investor-favoured sectors will be able to raise cheaper debt, but infrastructure and other sectors operating in capital-intensive, low-profitability sectors may find markets to be ruthless.

A broad-based institutional investor community can help. Pension funds, foreign portfolio investors, insurance companies and other long-term investors could bring variety in preferences and fund profiles.

The writer is an independent consultant.

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