What the new NPA ordinance means to banks?

While it may hasten the decision-making process for resolution of bad loans, other issues persist

With the bad loan book within the banking sector threatening to cross the Rs 7 lakh crore mark, the ordinance to empower the RBI to deal with the NPA issue, could not have come a day too soon.

But while the amendment of Section 35 A of the Banking Regulation Act, empowering the RBI to issue directions to banks and setting up oversight panels to look into loan recasts, will help resolve one set of issues plaguing the sector, it still has several weak links that may impede an effective resolution for the sector as a whole.

On the one hand, the proposals can remove several roadblocks in the decision-making process that have until now impeded resolution particularly in the case of PSU banks fearing backlash by central vigilance agencies. But whether the RBI has the necessary bandwidth to carry out assessment of all accounts across banks and whether banks are in a position to absorb huge losses on account of the RBI prescribed haircuts, needs to be seen.

Where earlier mechanisms failed

The CDR system of restructuring corporate debt was introduced in 2001, and covered companies which had taken loans from multiple lenders with an outstanding debt of Rs 10 crore or more. The scheme required the approval of 75 per cent of creditors by value. Short tenure of restructuring and inability of the promoters to infuse the requisite equity, only ended up ever-greening the problem, without offering any solution to revive the account.

RBI’s joint lenders’ forum (JLF) guidelines that came into effect in 2014 was intended to recognise stressed assets early and come up with a corrective action plan. The real challenge however with JLF was to get everybody on board and build consensus on debt restructuring.

Then came the Strategic Debt Conversion (SDR) which gave lenders the right to convert their outstanding loans into a majority equity stake if they felt that a change in ownership could help turnaround the borrower’s business. This too has not yielded the desired result due to couple of reasons.

One, while management change can help in cases where banks are convinced that the promoter has mala fide intent, these make up only a portion of the entire bad loan problem. The bulk of bad loans originate with firms which are stuck with over-capacity and weak demand and are unable to service their debt.

Two, finding ready buyers for large borrowers in core sectors within the 18-month window has proved to be difficult. Even if banks find suitable buyers, they have to take large haircuts on such sales.

The most recent tool introduced by the RBI was the Scheme for Sustainable Structuring of Stressed Assets or S4A allowing banks to convert up to half of the loans to stressed corporates into equity or equity like instruments.

The norms were only applicable to projects that have commenced operations and where the total exposure of all lenders in the account is more than Rs 500 crore. The sustainable portion of the loan, (not less than 50 per cent of the total debt) was to be decided based on what the corporate borrower can service against existing cash flows.

But the requirement of having a minimum 50 per cent of debt as sustainable has been a stumbling block according to most bankers.

Few key issues

All the existing arsenals with the banks to deal with stressed assets that have failed to have a meaningful impact on NPAs, suggest two or three key issues that have impeded resolution.

One is the unwillingness of banks to accept relevant haircuts. This could either be due to lack of decision-making or inability to absorb huge losses on account of haircuts. Structural issues plaguing core sectors such as power are also to be blamed.

Can new proposals help?

As far as ironing out the issues in the decision-making process for banks to take haircuts goes, the Amendment of Section 35 A of the Banking Regulation Act, can help. Bankers have been reluctant to take decisions fearing backlash in later years and by empowering the RBI to set up oversight panels to look into loan recasts, resolution could move forward.

But while this may help in certain accounts, huge haircuts may not be possible in case of highly-overleveraged companies.

Take for instance, Bhushan Steel which has a total debt of about Rs 42,300 crore as of FY16. If one assumes a 50 per cent haircut on the existing debt (given the very low interest cover of less than 0.5 times), this is way above the existing market capitalisation of the company which is about Rs 1,800 crore. The tale is similar for other companies such as GVK Power and JP Associate.

High debt to market-cap levels of some the indebted companies, may be a stumbling block for banks to take haircuts, even if directed by the RBI.

The other key issue is the poor state of finances of PSU banks. The net profit of PSU banks has been shrinking significantly over the past couple of quarters.

Huge haircuts would mean further hit on profitability and the Centre may have to end up footing the bill. Unless the RBI offers some leeway in provisioning (say apportioning it over a couple of quarters), prescribed haircuts may be difficult to implement.

Also the other key issue is whether the RBI has the necessary bandwidth to set up oversight committees and do an in-depth analysis of each account across banks. The Banks Board Bureau was put in place to do just that. But a year or so after getting operationalised, it has done little to improve the governance at PSU banks, as was envisioned by the P.J. Nayak Committee.

The RBI, according to the ordinance can also direct banks to initiate insolvency resolution under the Insolvency and Bankruptcy Code 2016. Given that the new code is still testing waters, it needs to be seen if it can prove effective where other earlier judicial mechanisms failed.

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