Resolving NPAs: No easy way out for RBI

While the Centre’s ordinance empowers the central bank, there are practical problems

Tackling the issue of non-performing assets (NPAs) of the banking system, which was increasingly looking like a process than an event, appears to have reached endgame with the government ordinance empowering the RBI to ‘resolve’ NPAs.

In many ways it is an unusual step, but it signals the urgency to get over the problem. Critics have been quick to point out several flaws in the scheme — primarily, the conflict of interest for the RBI in being a regulator and an enforcer, as also politically, given the possibilities of pick and choose decisions and even scepticism about Bankruptcy and Insolvency courts being able to clear the targeted 60-odd cases in nine months. These apart, there are a few other concerns with the approach.

Costs of economic loss

The first concern is over the costs of the economic loss involved. Since the approach will rely largely on the bankruptcy and insolvency processes, there is the tacit admission that these assets are beyond redemption.

The Economic Survey had indicated that no less than 57 out of the 100 top bad debts would need debt reductions of 75 per cent or more. If true, this will amount to a massive scale of sacrifices from lenders, given the size of the problem and the dim prospects of realising value from the assets.

We need to remember that the provisioning made by banks only takes care of their accounting losses — the economic loss from the potential write-offs still remains, which could be significant, and taxpayers may invariably have to pick up the bill.

Ignoring systemic factors

Anotherconcern is that the approach, especially if successful, could lead to the classic moral hazard problem. While bankruptcy proceedings and write-offs are undoubtedly legitimate mechanisms, in the enthusiasm for mending NPA ratios, we could be ignoring systemic factors leading to bad debts.

Unfortunately there is not much published analysis on bad loans, other than generic factors such as economic distress, poor corporate earnings or high leverage. These are no doubt valid, but then the question arises as to why an uptick in these very conditions, for example, reasonable GDP growth, improved corporate earnings and buoyant markets or the numerous restructuring schemes, could not help salvage many of the NPAs.

In fact, the premise of the restructuring was that economic turnaround would render assets valuable again. But contrarily, NPAs have continued to rise, even as credit stagnated, which meant that either the restructuring premise was flawed, or worse, that wilful defaults were exceptionally high. The latter especially raises governance and efficiency issues that must not get swept under the carpet by the resolution processes.

Restarting corporate lending

Finally there isno guarantee that even if successful in reducing systemic NPAs, the move would achieve its stated objective, viz. the revival of bank lending to corporate sector and the pick-up of the investment cycle. It is naïve to presume this alone will enthuse banks to restart corporate lending.

Banks are shying away from lending to large projects and infrastructure for different reasons — asset-liability mismatches, lending competencies and the viability of these sectors — not just due to the shackle of bad debts. This is clear from credit trends which show a marked preference for retail (almost entirely housing finance), with even PSU banks building up significant retail exposures.

On the demand side too, corporate spending is sluggish more due to the investment climate (excess capacity, muted demand) than the lack of bank credit. A point to ponder here is that if excess corporate leverage was believed to be a cause of NPAs, why would we now expect banks to open up their purses again.

Effectively what the ordinance addresses is the decision-making inertia in the banking system viz. the reluctance to recognise losses, coordination issues between consortium lenders and the fear of reprisal. The action shifts to bankruptcy courts and the judicial machinery, with success becoming a function of the latter’s efficiency.

The challenges are formidable — an untested new Bankruptcy code, an under-staffed judicial infrastructure with a potentially large workload (as the new Tribunals are also expected to handle erstwhile Company Law Board cases, winding-up petitions and other debt suits in courts). At the end of it all, there are still the issues of finding buyers for distressed assets and realising cash.

If the past experience with Debt Recovery Tribunals or SARFAESI Act is anything to go by, the new Bankruptcy Code and tribunals will have plenty of work to do to before we can conclude that a lasting solution to the problem has been found.

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