Since the Reserve Bank of India(RBI) have initiated asset quality review in the second half of 2015, almost a sixth part of gross advances of Public Sector Banks(PSB) have come under the head of stressed assets and a significant majority of these are non-performing asset(NPAs). The outcomes of Asset Quality Review exercise have come as a massive shocker to the reality of banking sector stirring a public debate on it. Two inferences that can be apparently drawn from the review exercise are, one that banks have hesitated in comprehensive recognition of stressed assets and second is selective concentration of these assets in sectors like infrastructure, power, telecom, and textiles.
The banks were reluctant to disclose the real scale of NPA’s was due to the fear of possible deposit cuts and wrath of shareholders. Further, because of short tenures of CEOs, this absence of market discipline in the management carried forward to the next CEO. The sectoral concentration of losses lead to identification of multiple companies having interest coverage ratio of less than one. Given the massive scale of the problem, Asset Reconstruction Companies (ARCs) could not help because of their turnaround capital capacity was limited. The option of liquidation of assets faced a major setback because of the demand of steep discounts, implying significant haircuts for bank debts. The loss of capital that would result on bank books and the fear of vigilance actions that such haircuts might trigger have made it almost impossible to get banks to embrace restructuring. One unfortunate feature of sectors with most stressed assets is that they have excessive capacity relative to current demand or near term utilization and thereby they offer no-sight of immediate pickup in economic prospects.
This situation should be a cause for concern to all of us. It is reminiscent of weak banks and stagnating growth witnessed by Japan in the 1990s, with repercussions to date, and by Italy since 2010. Japan has experienced, and Italy, is in my opinion experiencing, a lost decade. India being a country of 1.25 billion people shoulders the responsibility of fighting against the challenges of poverty, unemployment, and meeting basic social and infrastructural needs of its population. Given our healthy level of growth, macroeconomic stability and many other favorable economic factors, it becomes imperative to fight the challenge of stressed assets for meeting our long term goals and resolutions.
How do we embark on a better path?
The Government, Insolvency and Bankruptcy Board of India (IBBI) and the Reserve Bank have been working together to comprehensively address the challenge through a multi-pronged approach. Swift, time-bound resolution or liquidation of stressed assets becomes critical for de-clogging bank balance sheets and for efficient reallocation of capital. There are specific measures taken over the last few months, both by the Government and the Reserve Bank, to strengthen the legal, regulatory, supervisory and institutional framework are aimed at the ultimate objective of facilitating quick resolution of stressed assets in a time-bound manner.
Strengthening the Legal Framework :
- The enactment of the Insolvency and Bankruptcy Code, 2016 (IBC) is a watershed towards improving the credit culture in our country. Prior to the IBC, India had multiple laws that governed various facets of a corporate rescue and insolvency process, without having a comprehensive legal framework that envisages a holistic process applicable to troubled or defaulting companies. The IBC provides for a single window, time-bound process for resolution of an asset with an explicit emphasis on promotion of entrepreneurship, maximization of value of assets, and balancing the interests of all stakeholders.
- For a creditor, an asset, in most cases, is more valuable when it is a going concern and generates adequate cash flow, as compared to an asset under liquidation. IBC puts a time limit of 180 days (extendable by a further 90 days) within which creditors have to agree to a resolution plan, failing which the adjudicating authority under the law will pass a liquidation order on the insolvent company. So the threat of liquidation, which could potentially result in larger losses for the creditors as a whole, should be sufficient incentive for them to ensure efficient coordination during the insolvency resolution period so as to quickly arrive at a decision.
- For the promoter, the biggest cost of being pushed under IBC may be the possibility of losing the firm to potential bidders. This should incentivize the firms to avoid defaults and not over-borrow in the first place. This would improve the credit culture in the country.
- The Banking Regulation (Amendment) Ordinance, 2017 empowers the RBI to issue directions to banking companies to initiate an insolvency resolution process in respect of a default, under the provisions of the IBC. It also enables the Reserve Bank to issue directions with respect to stressed assets and specify one or more authorities or committees with such members as the Bank may appoint or approve for appointment to advise banking companies on resolution of stressed assets.
Evolving Regulatory Framework:
The Asset Quality Review (AQR) exercise undertaken in 2015-16 was a critical step in recognising the aggregate stock of non-performing assets across the banking system – it was a form of “catch-up”. Further, additional tools to deal with problem assets were also introduced, in the absence of an effective resolution framework. These tools primarily facilitate optimal structuring of credit facilities, ability to change ownership/management, and help restructuring of stressed assets. A framework was put in place for greater transparency in sale of stressed assets by banks with a view to ensuring the sale is at market determined prices.
The Way Forward:
The success and credibility of all the resolution efforts detailed above would be critically contingent on the strength of the public sector balance sheets to absorb the costs. It is clear that PSBs will need to take haircuts on current exposures under any resolution plan. Higher provisioning requirements, on this count as well as other factors, will affect the capital position of several banks. This would necessitate a higher recapitalization of the public sector banks. The Government and the Reserve Bank are in dialogue to prepare a package of measures to enable PSBs to shore up requisite capital in a time-bound manner. The measures could include a combination of capital raising from the market; dilution of government holdings; additional capital infusion by the Government; mergers based on strategic fit; sale of non-core assets etc.
Conclusively it can be said that there are pains and costs to be borne, but as long as the end-game is a desirable goal, these should be worth it for placing the economy structurally on a path of sustained growth.