The CEOs of
India’s debt-laden state-owned banks probably celebrated Christmas ahead of its
arrival in December – after an extremely stressful year, relentlessly chasing
rogue corporate borrowers for recovery of the monies lent. Finance Minister
Arun Jaitley played Santa Claus for them by seeking Parliament’s approval for Rs.
410 billion capital infusion in these banks.
The government
had budgeted for Rs. 650 billion fund infusion during the current year, of
which Rs. 420 billion is still to be allotted. This means, Rs. 830 billion will
flow into the public sector banks (PSBs), taking the total sum to Rs. 1.06
trillion by March, 2019.
In October,
2017, the government had announced a staggering Rs. 2.11 trillion capital
infusion in phases into PSBs that have little less than 70% share of the assets
of the Indian banking industry. The new package, for which Parliament’s nod has
been sought, is part of that.
Incidentally,
between 1985-86 and 2016-17, in little over a decade, the government had
injected Rs. 1.5 trillion into these banks; the bulk of this flowed in since
the global financial crisis of 2008, triggered by the collapse of the iconic US
investment bank Lehman Brothers Holding Inc.
To ward off the
impact of the crisis, the Reserve Bank of India (RBI) flooded the banking
system with money and brought down the policy rate to a historic low, less than
the savings bank rate which was regulated then. With too much money, coupled
with pressure from various quarters to lift consumption, banks lent recklessly
and that led to the creation of bad assets.
IS THE SCENE GETTING BETTER?
In September,
2018, after the annual ritual of a review meeting with the chiefs of PSBs,
Jaitley said that non-performing assets (NPAs) with these banks were on the
decline and Rs.1.8 trillion worth of recovery of bad loans could happen during
fiscal year 2019.
According to
him, in the first quarter of the year (April-June, 2018), the lenders recovered
Rs. 365.5 billion. This is 49% higher than the corresponding quarter of the previous
year. During the entire 2018 fiscal year, banks recovered Rs. 745.6 billion.
“It’s still early days of the IBC (Insolvency and Bankruptcy Code), but already
the impact is clearly visible,” Jaitley said.
He also said
that the NPAs with the PSBs were declining.
“The last quarter saw PSU banks with a net profit. On the basis of the
last quarter and what their expectations are looking ahead, the good news is
that NPAs are on the decline because recoveries have picked up.”
Indeed, the
recovery of bad loans at PSBs gained momentum in the June, 2018 quarter; their
operating profits rose and the overall asset quality improved. Besides, the
provision coverage ratio of these banks has gone up to 63.8%, he pointed out.
The listed
banks’ kitty of gross NPAs dropped marginally—a little more than 2% from
Rs.10.25 trillion in March to Rs. 10.03 trillion in June. For PSBs, the drop is
2.5%, from Rs. 8.97 trillion to Rs. 8.74 trillion. In September, it dropped
further – Rs. 8.69 trillion.
Clearly, the
pace of fresh slippage has slowed. Aided by provision and aggressive
write-offs, the net NPAs of all listed banks have dropped a little over 6%,
from Rs. 5.18 trillion to Rs. 4.85 trillion in June and Rs. 4.83 trillion in
September.
Incidentally,
the PSBs’ share in bad loans is far higher than their share in banking assets.
All these data
say that things are getting better, but a closer look at some of the banks’ bad
loan pile-ups clearly signal that the party time has not arrived as yet.
Let us take a
look at some individual banks. Twelve of the 21 PSBs were in losses in
September, 2018. Among them, IDBI Bank posted loss in 10 of the past 12
quarters, since December, 2015 (when the NPAs of the banking system started
rising following the RBI intervention), to the tune of Rs. 236 billion. The
trio of Indian Overseas Bank, Central Bank of India and Uco Bank have made losses in all 12
quarters (collectively, Rs. 375 billion). Dena Bank and Bank of Maharashtra
seem better off – they have recorded losses in 11 quarters (Rs. 94 billion).
Overall, during
this period, the PSBs recorded Rs. 1.84 trillion losses, around 1.2% of India’s
GDP. This also exceeds the total capital infusion in 31 years between 1986 and
2017, one-third of which — Rs. 500 billion — flowed in 2016 and 2017. By the
December quarter, the losses will probably exceed the big bang recap of Rs. 2.1
trillion.
Four PSBs’
advance portfolios declined in the September quarter compared with June and, if
we compare them with a year-ago period, as many as 11 of them have shrunk their
loan books. For two of them, the drop is as much as 10% or more. Similarly for
PSBs, the deposit kitties shrank in the September quarter compared with June;
if we compare them with the year-ago period, then seven banks have shrunk their
deposit portfolios. The RBI restrictions do not impact deposit mobilisation.
Finally, six
banks’ gross NPAs surged in September from the June level. Ditto about five
banks’ net NPAs. In September, at least one bank (IDBI Bank) had more than 30%
gross NPAs and another five (Uco
Bank, Indian Overseas Bank, Dena Bank, United Bank, Central Bank) more than 20%
but less than 25%, even as six banks had more than 15% gross NPAs. When it
comes to net NPAs, nine of them had more than 10% and up to 17.3%; for a few of
them the asset quality deteriorated further in September.
THE NPA SAGA
The NPA saga
started in 2014 but gained momentum in 2016 after the Reserve Bank of India
(RBI), under former Governor Raghuram Rajan, instituted an asset quality review
(AQR) whereby the inspectors of the Central bank audited the banks’ loan books
and identified bad assets. The exercise was completed in October, 2015 and the
banks were directed to come clean in six quarters between December, 2015 and
March, 2017.
In a detailed presentation
to a Parliamentary Committee, Rajan has explained what went wrong in the Indian
banking system.
According to
him, a larger number of bad loans originated in 2006-2008 when the Indian
economy grew at over 9% for three years in a row. “This is the historic
phenomenon of irrational exuberance, common across countries at such a phase in
the cycle.”
In the
aftermath of the collapse of Lehman Brothers, the world witnessed an
unprecedented liquidity crisis and India too could not escape the fallout. The
strong demand projections for various projects started looking increasingly
unrealistic as domestic demand slowed down.
Around the same
time, a variety of governance problems, such as the suspect allocation of coal
mines coupled with the fear of investigation, slowed down the government
decision-making. As a result of this, cost overruns escalated for stalled
projects and they became increasingly unable to service debt.
And, once the
projects got delayed to the extent that the promoters had little equity left in
the project, they lost interest. “Ideally, projects should be restructured at
such times, with banks writing down bad debt that is uncollectable, and
promoters bringing in more equity, under the threat that they would otherwise
lose their project. Unfortunately, until the Bankruptcy Code was enacted,
bankers had little ability to threaten promoters, even incompetent or
unscrupulous ones,” Rajan has said.
He has also
mentioned that unscrupulous promoters who had inflated the cost of capital equipment
through over-invoicing were rarely checked and the PSBs continued financing
promoters even as the private sector banks were getting out. Finally, too many
loans were made to well-connected promoters who had a history of defaulting on
their loans.
What Rajan has
not mentioned is that most Indian banks do not have the expertise for project
financing. Till the late 1990s when RBI pulled down the walls between
commercial banks and development financial institutions (DFIs) and the DFIs
were allowed to die while the commercial banks turned themselves into universal
banks, these banks were primarily into financing the working capital needs of
corporations. They got into term lending after the demise of DFIs but never
acquired the expertise to do so.
Do all these
banks know how to lend? Had they known, they would not be in such a mess.
Typically, the PSB bosses blame the state of the economy for the rise in bad
loans but this is not convincing as the private banks too
operate in the same milieu and many of them have far better asset quality.
BANK RECAPITALISATION
Officially, the
government does not want to treat this as a dole. Both the government and the
RBI seem to be keen that banking reforms and recapitalisation must go
hand-in-hand. In other words, the taxpayers’ money will not be continuously
pumped in just to keep PSBs alive.
To put the
story of bank recapitalisation in context, capital is core to banks for
expanding credit, earning interest and growing their balance sheets so that
they can drive economic activities. The government is the majority owner of
PSBs in India. The statutory requirement in the Banking Companies (Acquisition
and Transfer of Undertakings) Act, 1970/1980, and the State Bank of India Act,
1955, ensure that the Indian government shall, at all times, hold not less than
51% of the paid-up capital in such banks.
In 2010, the
Cabinet Committee on Economic Affairs (CCEA), after taking into account the
trends of the economy, had decided to raise government holding in all PSBs to
58%. The objective was to create a headroom and enable PSBs to raise capital
from the market when they need it, without compromising their public sector
character.
Subsequently,
in December, 2014, the CCEA decided to allow PSBs to raise capital from the public
markets through instruments such as follow-on public offer or qualified
institutional placement by diluting the government holding up to 52%, in a
phased manner.
The regulatory
requirements of capital adequacy and credit growth are the two main drivers for
bank capitalisation. The regulatory architecture is globally framed by the
Basel Committee on Banking Supervision — a committee of bank supervisors
consisting of members from representative countries. Its mandate is to
strengthen the regulation, supervision and practices of banks and enhance
financial stability.
So far, three
sets of Basel norms have been issued. The Basel I norms were issued in 1988 to
provide, for the first time, a global standard on the regulatory capital
requirements for banks. The Basel II norms, introduced in 2004, further
strengthened the guidelines for risk management and disclosure requirements.
This called for
a minimum capital adequacy ratio (CAR) — or, capital to risk-weighted assets
ratio (CRAR) as it is the ratio of regulatory capital funds to risk-weighted
assets — which all banks with an international presence are to maintain. These
norms were revisited again in 2010 — known as Basel III norms — in the wake of
the sub-prime crisis and large-scale bank failures in the US and Europe. Basel
III emphasised on capital adequacy to protect shareholders’ and customers’
risks and set norms for Tier I and Tier II capital.
The capital can
come either from their dominant shareholder (the government of India) or the
capital market. The PSBs’ underperformance and the pile of bad loans leading to
low book value come in the way of accessing the capital market. There is a
significant gap between the book value and market value of PSB shares, with
most PSBs having a lower market value, compared with their book values. Hence,
the government as the majority stakeholder needs to step in to rescue PSBs.
THE FUTURE TRAJECTORY
How long will
it take for the Indian banks to bring down their NPAs? The December, 2017
Financial Stability Report of the RBI, a bi-annual reality check of the Indian
financial system, had suggested that the gross NPAs in the Indian banking
system may rise from 10.2% in September, 2017 to 10.8% in March, 2018, and an
even higher 11.1% by September, 2018. The actual bad loan figure of March, 2018
was higher than the estimate.
And the June,
2018 Financial Stability Report said the gross NPAs may rise from 11.6 % in
March, 2018 to 12.2% by March, 2019. Besides, the system-level
capital-to-risk-weighted assets ratio (CRAR) may come down from 13.5% to 12.8%
during the period; 11 public sector banks under prompt corrective action
framework may experience a worsening of their gross NPA ratio from 21% in March
2018 to 22.3% with six PSBs likely experiencing capital shortfall relative to
the required minimum CRAR of 9%.
The AQR is just
the beginning of the RBI actions to unearth the mound of NPAs. At the next
stage, the Central bank took a series of steps to force the banks to chase the
defaulters for recovery as well as punish the banks for not doing enough to
clean up their balance sheets.
MORE DISCLOSURES
In April, 2017, an RBI notification
said, “There have been instances of material divergences in banks’ asset
classification and provisioning from the RBI norms, thereby leading to the
published financial statements not depicting a true and fair view of the
financial position of the bank.” The regulator advised the banks to make
adequate disclosures of such divergences in the notes to accounts in their
annual financial statements.
RBI inspectors
found these when they took a close look at the loan books of all banks while
carrying out the asset quality review in 2015.
Under the
regulatory norms, when a borrower is not able to service a loan for three
months, it becomes an NPA and the lender needs to set aside money or provide
for it. However, there could be divergence as under certain circumstances, one
can take a “view” on whether a particular loan is good or bad. For instance,
when the principal or interest payment for a particular loan is overdue between
61 and 90 days (and not exceeding 90 days), this becomes a special mention
account-2 ( SMA-2). If a loan exposure continues to be in this category for
months, a prudent banker would prefer to classify it as an NPA even though
technically it can continue to be treated as a standard asset.
Then, there are complexities for some of the
restructured infrastructure loans. There have been cases where banks have given
the borrowers more time, depending on the date of commencement of commercial
operations. Many such loans have been restructured twice and continue to be
tagged as standard assets in banks’ books. Often, the date of commencement of
commercial operations is subject to interpretation and the RBI may not be
comfortable with such cases.
While
conducting the AQR, RBI inspectors had found many instances of the same loan
exposure being classified as bad by one bank but good by another.
The annual
reports of quite a few banks in the past two years showed “divergence” or a
difference – which in some cases was quite huge – between the lender’s
assessment of bad loans and that of the RBI. As a result of this divergence,
the difference in provisioning is also stark and banks have shown lesser NPAs
than what the RBI assessment had suggested. In other words, had there been no
divergence, these banks would have shown lesser profit and higher NPAs.
Subsequently,
in May, 2017, the RBI was empowered through an Ordinance to issue directions to
banks to initiate insolvency proceedings against borrowers for resolution of
stressed assets. The Banking Regulation (Amendment) Ordinance, 2017 was
promulgated on 4th May, 2017. This Ordinance empowered the RBI to
direct banking companies to initiate insolvency proceedings in respect of a
default under the provisions of the Insolvency and Bankruptcy Code, 2016 (IBC).
It also enabled the RBI to constitute committee/s to advise banking companies
on resolution of stressed assets.
Armed with the
Ordinance, the Central bank in June, 2017 asked banks to initiate insolvency
proceedings against 12 large bank defaulters with a total debt of over Rs. 2
trillion, around 25% of the banking system’s bad assets at that time.
It followed
this up in August, 2017 by sending a second list of 28 defaulters to the
lenders to initiate debt resolution before December 13, failing which these
cases would have to be sent to the National Company Law Tribunal (NCLT) before
December, 2017. Between them, these 40 loan accounts have roughly 40% share of
the Rs. 10 trillion bad assets in the Indian banking system.
THE FEBRUARY 2018 CIRCULAR
Finally, in February,
2018, the RBI tightened its rules on bank loan defaults, sought to push more
large defaulters towards bankruptcy courts and abolished all existing
loan-restructuring platforms. The objective was to speed up the process of
resolution of the bad loans.
The recovery
drive for the banking industry started with the Debts Recovery Tribunals
(DRTs), set up under the Recovery of Debts Due to Banks and Financial
Institutions (RDDBFI) Act, 1993. Almost a decade later, the Securitisation and
Reconstruction of Financial Assets and Enforcement of Security Interests
(SARFAESI) Act, 2002 came into force to help banks and financial institutions
enforce their security interests and recover dues. Still, the recovery did not
get momentum. For instance, in 2013-14 recovery under DRTs was Rs. 305.9
billion while the outstanding value of debt sought to be recovered was close to
Rs. 2.37 trillion.
The platforms
such as corporate debt restructuring (CDR), strategic debt restructuring (SDR)
and the scheme for sustainable structuring of stressed assets (S4A) which were
used to clean up the bank balance sheets were all abolished late night on 12th
February, 2018.
SDR, introduced
in June, 2015, gave banks the power to convert a part of their debt in stressed
companies into majority equity, but it didn’t work because promoters delayed
the restructuring, dangling the promise of bringing in new investors. Before
that, in February, 2014, RBI had allowed a change in management of stressed
companies. The principle of the restructuring exercise was that the
shareholders must bear the first loss and not the lenders; and the promoters
must have more skin in the game.
This was done
after the regulator realised that the CDR mechanism, put in place in August,
2001, could not do much to alleviate the pain of the lenders. Any loan exposure
of Rs. 10 crore and more (including non-fund limits) and involving at least two
lenders could have been tackled on this platform.
The S4A scheme
allowed the banks to convert up to half the loans of stressed companies into
equity or equity-like securities. Meant for restructuring companies with an
overall exposure of at least Rs. 500 crore, this scheme could come into play
only when the bankers were convinced that the cash flows of the stressed
companies were enough to service at least half of the funded liabilities or
“sustainable debt”. Not much, however, could get resolved under this scheme
either.
After ushering
in a new bankruptcy regime in 2016, the RBI got more powers in 2017 to force
the lenders to deal with 40 biggest corporate loan defaulters. The February,
2018 norms took the story forward.
The rules,
released on 12th February, stipulate that starting 1st
March, lenders must implement a resolution plan within 180 days for defaulted
loan accounts above Rs. 2,000 crore. Failing to do so, the account must be
referred to insolvency courts. They also mandate banks to report defaults
weekly to RBI, even if loan payments are delayed by a day. These norms replaced
earlier schemes such as strategic debt restructuring, 5/25 refinancing, the
Corporate Debt Restructuring Scheme, and the Scheme for Sustainable Structuring
of Stressed Assets, among others, with immediate effect. “All accounts,
including such accounts where any of the schemes have been invoked but not yet
implemented, shall be governed by the revised framework,” the RBI said.
It warned that
any failure on the part of banks to meet the prescribed timelines, or any
actions they take to conceal the actual status of accounts or evergreen
stressed accounts, will expose banks to stringent actions, including monetary
penalties.
The rules
around resolution plans were also tightened and restructuring of large accounts
with loans of Rs.100 crore or more would need independent credit evaluation by
credit rating agencies authorised by the Central bank. Loans of Rs. 500 crore
or more would need two such independent evaluators.
NO LONGER IN A DENIAL MODE
As a result of
the series of steps taken by the regulator, Indian banks are no longer in
denial mode. Indeed, in the past, they were slow in recognising bad assets as
such recognition hits their profitability since they need to provide for or set
aside money for NPAs. Which is why, traditionally, bankers try hard not to
allow any loan to slip into NPAs through various ways. But the relentless
pressure of the banking regulator has changed the scene. The bankers are not
taking any chances for any loan account any more. Once it’s gone bad, they are
swift in classifying it as an NPA and providing for it.
Once shy in
recognition and resolution of NPAs for fear of being hit on profitability and a
backlash from investors, bankers are now bold and walking the extra mile to
settle with loan defaulters. They don’t care much about the depth of the
haircut and impact on their balance sheets.
However, this
detoxification exercise has its own challenges through early recognition of
stressed assets and increased provisioning. To add to the banker’s woes,
frequent involvement by investigative agencies, arrests of a few bankers and
stripping the powers of a few others have created a fear psychosis. Bankers are
tending to opt for a relatively safer and optically transparent path, even at
the cost of recovery maximisation.
Today, the
impact of major economic reforms such as Demonetisation, GST, RERA has
stabilised and recognition of the bad loans has largely been done. We are
probably at the final stage of detoxification.
Though this
period has been mired by quite a few litigations, which were expected, IBC
being a new legislation, the message has been conveyed aptly to the corporate
world. The IBC has not only provided a legal framework to systematically
address the NPAs of the banking system with a strong armoury to lenders, but
also put borrowers who were looking for an easy escape route from the situation
on the back foot.
Japan, which
introduced the bankruptcy law in 2004, takes six months to settle a case and
the recovery rate is close to 93%. For UK, which introduced it in 2002, the
recovery rate is 88.6% and settlement within a year, while US, where insolvency
law is 40 years old, it takes 18 months to settle a case at a recovery rate of
80.4%. It’s still early days in India but the IBC has made a new beginning for
the banking system. With the recovery picking up, albeit slowly, the banks are
being encouraged to lend and support economic growth. The first signs of this
are already visible – the credit growth in India is at a four-year high.
