The Financial Stability Report (FSR) released by RBI recently has once again underlined the vulnerability of the Indian public sector banks (PSBs). They have been under a severe balance sheet crisis even before the pandemic, and the crisis created by the pandemic, and the moratorium offered, will explode when the chickens come to roost.

Current banking scenario in India

According to the FSR

• The gross non-performing assets would go up from 11.3% in March 2020 to 15.2% in March 2021, and to 16.3% under a very severe stress scenario. 
• The CRAR is estimated to deteriorate from 14.6% in March to 13.3% in the baseline scenario, and to 11.8% under a very severe stress scenario. 
• The volume of recapitalisation required is humongous.

What is a Non-Performing Asset (NPA)?

• You may note that for a bank, the loans given by the bank is considered as its assets. So if the principle or the interest or both the components of a loan is not being serviced to the lender (bank), then it would be considered as a Non-Performing Asset (NPA).
• Any asset which stops giving returns to its investors for a specified period of time is known as Non-Performing Asset (NPA).
• Generally, that specified period of time is 90 days in most of the countries and across the various lending institutions. However, it is not a thumb rule and it may vary with the terms and conditions agreed upon by the financial institution and the borrower.

Reasons for rise in NPA in India

• Historical factors -Between early 2000’s and 2008 Indian economy were in the boom phase. During this period Banks especially Public sector banks lent extensively to corporate. However, the profits of most of the corporate dwindled due to slowdown in the global economy, the ban in mining projects, and delay in environmental related permits affecting power, iron and steel sector, volatility in prices of raw material and the shortage in availability of. This has affected their ability to pay back loans and is the most important reason behind increase in NPA of public sector banks.
• Relaxed lending norms : One of the main reasons of rising NPA is the relaxed lending norms especially for corporate honchos when their financial status and credit rating is not analyzed properly. Also, to face competition banks are hugely selling unsecured loans which attributes to the level of NPAs.
• Lack of contigency planning: Banks did not conducted adequate contingency planning, especially for mitigating project risk. They did not factor eventualities like failure of gas projects to ensure supply of gas or failure of land acquisition process for highways.
• Restructuring of loan facility was extended to companies that were facing larger problems of over-leverage& inadequate profitability. This problem was more in the Public sector banks.
• Unforseen economic shocks like Demonetization and Covid 19

What is the impact of NPAs?

• Lenders suffer a lowering of profit margins.
• Stress in banking sector causes less money available to fund other projects, therefore, negative impact on the larger national economy.
• Higher interest rates by the banks to maintain the profit margin.
• Redirecting funds from the good projects to the bad ones.
• As investments got stuck, it may result in it may result in unemployment.
• In the case of public sector banks, the bad health of banks means a bad return for a shareholder which means that the government of India gets less money as a dividend. Therefore it may impact easy deployment of money for social and infrastructure development and results in social and political cost.
• Investors do not get rightful returns.
• Balance sheet syndrome of Indian characteristics that is both the banks and the corporate sector have stressed balance sheet and causes halting of the investment-led development process.
• NPAs related cases add more pressure to already pending cases with the judiciary.

What are the various steps taken to tackle NPAs?

1.Corporate Debt Restructuring – 2005

It is for reducing the burden of the debts on the company by decreasing the rates paid and increasing the time the company has to pay the obligation back.

2.5:25 rule – 2014

• Also known as, Flexible Structuring of Long Term Project Loans to Infrastructure and Core Industries.
• It was proposed to maintain the cash flow of such companies since the project timeline is long and they do not get the money back into their books for a long time, therefore, the requirement of loans at every 5-7 years and thus refinancing for long term projects.

3.Joint Lenders Forum – 2014

• It was created by the inclusion of all PSBs whose loans have become stressed. It is present so as to avoid loans to the same individual or company from different banks.
• It is formulated to prevent instances where one person takes a loan from one bank to give a loan of the other bank.

4.Mission Indradhanush – 2015

The Indradhanush framework for transforming the PSBs represents the most comprehensive reform effort undertaken since banking nationalization in the year 1970 to revamp the Public Sector Banks (PSBs) and improve their overall performance by ABCDEFG.

• A-Appointments: Based upon global best practices and as per the guidelines in the companies act, separate post of Chairman and Managing Director and the CEO will get the designation of MD & CEO and there would be another person who would be appointed as non-Executive Chairman of PSBs.
• B-Bank Board Bureau: The BBB will be a body of eminent professionals and officials, which will replace the Appointments Board for the appointment of Whole-time Directors as well as non-Executive Chairman of PSBs
• C-Capitalization: As per finance ministry, the capital requirement of extra capital for the next four years up to FY 2019 is likely to be about Rs.1,80,000 crore out of which 70000 crores will be provided by the GOI and the rest PSBs will have to raise from the market.

• D-DEstressing: PSBs and strengthening risk control measures and NPAs disclosure.
• E-Employment: GOI has said there will be no interference from Government and Banks are encouraged to take independent decisions keeping in mind the commercial the organizational interests.
• F-Framework of Accountability: New KPI(key performance indicators) which would be linked with performance and also the consideration of ESOPs for top management PSBs.
• G-Governance Reforms: For Example, Gyan Sangam, a conclave of PSBs and financial institutions. Bank board Bureau for transparent and meritorious appointments in PSBs.

5.Strategic debt restructuring (SDR) – 2015

• Under this scheme banks who have given loans to a corporate borrower gets the right to convert the complete or part of their loans into equity shares in the loan taken company. Its basic purpose is to ensure that more stake of promoters in reviving stressed accounts and providing banks with enhanced capabilities for initiating a change of ownership in appropriate cases.

6.Asset Quality Review – 2015

• Classify stressed assets and provision for them so as to secure the future of the banks and further early identification of the assets and prevent them from becoming stressed by appropriate action.

7.Sustainable structuring of stressed assets (S4A) – 2016

• It has been formulated as an optional framework for the resolution of largely stressed accounts. 
• It involves the determination of sustainable debt level for a stressed borrower and bifurcation of the outstanding debt into sustainable debt and equity/quasi-equity instruments which are expected to provide upside to the lenders when the borrower turns around.

8.Insolvency and Bankruptcy code Act-2016

• It has been formulated to tackle the Chakravyuha Challenge (Economic Survey) of the exit problem in India.
• The aim of this law is to promote entrepreneurship, availability of credit, and balance the interests of all stakeholders by consolidating and amending the laws relating to reorganization and insolvency resolution of corporate persons, partnership firms and individuals in a time-bound manner and for maximization of value of assets of such persons and matters connected therewith or incidental thereto.

9.Pubic ARC vs. Private ARC – 2017

• This debate is recently in the news which is about the idea of a Public Asset Reconstruction Companies (ARC) fully funded and administered by the government as mooted by this year’s Economic Survey Vs. the private ARC as advocated by the deputy governor of RBI Mr. Viral Acharya.
• Economic survey calls it as PARA (Public Asset Rehabilitation Agency) and the recommendation is based on a similar agency being used during the East Asian crisis of 1997 which was a success.

10.Bad Banks – 2017

• Economic survey 16-17, also talks about the formation of a bad bank which will take all the stressed loans and it will tackle it according to flexible rules and mechanism. It will ease the balance sheet of PSBs giving them the space to fund new projects and continue the funding of development projects.

11.Prompt corrective action

• PCA is a framework under which banks with weak financial metrics are put under watch by the RBI.
• The RBI introduced the PCA framework in 2002 as a structured early-intervention mechanism for banks that become undercapitalised due to poor asset quality, or vulnerable due to loss of profitability.
• It aims to check the problem of Non-Performing Assets (NPAs) in the Indian banking sector.

12.RBI’s revised stressed asset resolution norms

• The RBI in June 2019 released a revised set of norms on stressed asset resolution which are substantially less stringent from the previous one.

About the February 2018 RBI circular

• Through a notification issued on Feb 12, 2018 the RBI laid down a revised framework for the resolution of stressed assets, which replaced all its earlier instructions on the subject.
• Banks were required to immediately start working on a resolution plan for accounts over Rs 2,000 crore, which was to be finalised within 180 days.
• In the case of non-implementation, lenders were required to file an insolvency application.
• RBI termed it necessary to substitute the existing guidelines with a harmonized and simplified generic framework for resolution of stressed assets.
• Also, banks have to recognise loans as non-performing even if the repayment was delayed by just one day.
• Not adhering to the timelines in the circular would attract stringent supervisory and enforcement actions.

What did the revised framework replace?

• The circular went into effect on the same day that it was issued, and all existing schemes for stressed asset resolution were withdrawn with immediate effect.
• The circular was ostensibly intended to stop the “evergreening” of bad loans the practice of banks providing fresh loans to enable timely repayment by borrowers on existing loans.
• The RBI warned banks that not adhering to the timelines laid down in the circular, or attempting to evergreen stressed accounts, would attract stringent supervisory and enforcement actions.

New circular of the RBI

• The new framework gives lenders a breather from the one-day default rule whereby they had to draw up a resolution plan (RP) for implementation within 180 days of the first default.
• It gives lenders (scheduled commercial banks, all-India financial institutions and small finance banks) 30 days to review the borrower account on default.
• During this review period, lenders may decide on the resolution strategy, including the nature of the RP and the approach for its implementation.
• Lenders may also choose to initiate legal proceedings for insolvency or recovery.
• The new circular is also applicable to small finance banks and systemically important non-deposit taking non-banking financial companies (NBFCs) and deposit-taking NBFCs.
• In cases where the RP is to be implemented, all lenders have to enter into an intercreditor agreement (ICA)for the resolution of stressed assets during the review period to provide for ground rules for finalisation and implementation of the RP in respect of borrowers with credit facilities from more than one lender.
• Under the ICA, any decision agreed to by the lenders representing 75 per cent of total outstanding credit facilities by value and 60 per cent by number will be binding upon all the lenders. In particular, the RPs will provide for payment which will not be less than the liquidation value due to the dissenting lenders.
• In cases where the aggregate exposure of a borrower to lenders (scheduled commercial banks, all-India financial institutions and small finance banks) is ₹2,000 crore and above, the RP has to be implemented within 180 days from the end of the review period, and the reference date has been set as June 7, 2019.
• In the case of borrowers in the ₹1,500 crore and above but less than ₹2,000 crore category, January 1, 2020 has been set as the reference date for implementing the RP. In the less than ₹1,500 crore category, the RBI will announce the reference date in due course.

 What if the Resolution Plan is delayed?

• There is a disincentive for banks if they delay implementing a viable resolution plan.
• In case the plan is not implemented within 180 days from the end of the review period, banks have to make additional provision of 20% and another 15% if the plan is not implemented within 365 days from the start of the review period.
• The additional provisions would be reversed if resolution is pursued under Insolvency and Bankruptcy Code (IBC).

Further reforms needed

• Banks have to accept losses on loans (or ‘haircuts’).
• They should be able to do so without any fear of harassment by the investigative agencies.
• The Indian Banks’ Association has set up a six-member panel to oversee resolution plans of lead lenders. To expedite resolution, more such panels may be required.
• An alternative is to set up a Loan Resolution Authority, if necessary through an Act of Parliament.
• Also, the government must infuse at one go whatever additional capital is needed to recapitalise banks — providing such capital in multiple instalments is not helpful
• The quality of lending by PSB must be improved in future so that the same problem does not arise again.
• To provide Public sector banks with greater autonomy the shareholding of the government can be reduced to less than 50 percent or 33 percent.
• A second requirement is that public sector banks should become board-managed institutions, with the board responsible for all appointments, including that of the chief executive officer (CEO). If the shares of the government are actually transferred to a holding company, then decisions regarding appointments could be taken by the board of the new company on the recommendation of the board of the bank.
• The objective of creating a genuinely commercial environment in which public sector banks can function and managements are made accountable can only be achieved if the government is willing to step back from exercising direct control. 

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