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Indian Bank Troubles: NPA Spring Cleaning Quite the Task

Founder and CEO, Transfin.
Apr 14, 2016 4:30 AM 4 min read

Sticky Situation: Resolving Indian Bank NPA Woes

RBI’s 2015 Financial Stability Report provides a clear picture of Indian banks’ deteriorating asset quality. As in September 2015, 14.1% of total loans handed by PSBs are stressed. Their share has tripled since 2009, with medium and large corporate borrowers constituting a lion’s share of distressed counterparties.

The ongoing bad debt debacle isn’t merely about failure in risk management or questionable corporate ethics. It also highlights the unfairness of our financial and legal system. There is something seriously wrong when ordinary citizens are expected to demonstrate the utmost compliance to procedure, while a well-connected individual or organisation gets away with major lapses. The resulting discussion is not always objective, but is the right one to have.

The government has been working on multiple fronts to tackle these areas. The 7-point Mission Indradhanush forms the principal action plan so far. Its highlight is its recapitalization plan of Rs 70,000 crore into major PSBs. The program includes recommendations to improve governance by separating positions of the non-executive chairman and managing director, and the set-up of an overarching ‘independent’ Banks Board Bureau (BBB) to act as a buffer between the government and management, and take the role of an appointments board for all PSBs to choose their directors.

The idea is to minimise possible interference from the government, promote transparency, and review the business models of PSBs to operate them as private-run enterprises. But the plan lacks detail on many fronts.

Another area of ongoing discussion concerns bankruptcy reforms. The Insolvency and Bankruptcy Code was introduced in Lok Sabha in December 2015. Insolvency is currently driven by various laws and agencies with overlapping jurisdictions, resulting in low recoveries and long delays. India is ranked 136 (out of 189 countries) in resolving insolvency by the World Bank, with average proceedings lasting 4.3 years and average recovery of merely 26 cents to a dollar.

This Bill represents the first attempt to have a uniform bankruptcy law in India. The proposal includes the setting up of an insolvency regulator, separating tribunals for unlimited and limited liability firms, utilising insolvency professionals to develop best practices, building a comprehensive insolvency database, and a clear layout for both resolution and liquidation within 180/270 days. A transitional program to fill the gaps between the legislation and implementation is as important as the legislation itself.

The new insolvency regulator should ideally be created by the time the law is passed. An interim regulator would only dilute the effectiveness of enforcement. Similarly, the National Company Law Tribunal (NCLT) to oversee limited liability cases needs to be created. Already existing debt recovery tribunals require realignment with increased resources and infrastructure.

The government’s intentions are in the right place. But a disconnect amongst different agencies is visible. For instance, the RBI has set a deadline of March 2017 to provision for all existing NPAs. The resulting provision charge and higher risk weights decrease banks’ profitability and erode their capital ratios. This deterioration is very visible as per the latest RBI data and translates into lower valuation levels.

Low relative valuations reduces flexibility to raise capital, due to issuance discounts and shareholder dilution. They also limit consolidation options as any equity funded acquisition loses attraction from a financial impacts perspective.

Expecting PSBs to suffer from reduced profitability, valuations and capital constraints without adequate financial support is akin to climbing a mountain with one arm tied behind.

A higher capital injection from the government is required, but not on a silver platter. It should rather serve as a bargaining chip for more fundamental reform covering governance, transparency and ownership. It is also essential to destress the sector by developing the corporate bond market.

Governance and transparency issues which may be revisited include creation of empowered independent boards, removal of dual regulation, and possible reduction of government stakes. Current boards of PSBs require drastic overhaul, visible through their failure to assert adequate checks on the loan approval process, in spite of having RBI nominee members.

The PJ Nayak commitee recommendations lay a 3-step transition process comprising of transferring all government stakes to a bank investment company (BIC), setting up a BBB, and empowering boards by transferring oversight. The only specific action by the government so far is limited to the BBB. A structural change in governance would require the rest. Removal of dual regulation and reduction of government stakes, though politically sensitive, require consideration as part of wider reform.

Finally, the development of a robust corporate bond market will provide optionality to borrowers and allow bank balance sheets to de-stress. Currently our bond market comprises primarily of government securities. Corporate borrowers, besides the large listed players, generally depend on bank loans for their financing needs.

On the occasion when they tap the bond market, it is usually through private placements rather than public issuances. The reason for this is the lack of a wide investor base and appetite, insufficient transparency from issuers, absence of liquid price benchmarks, a nonfunctioning Credit Default Swaps (CDS) market to provide protection, and no harmonised bankruptcy framework.

A comprehensive review is essential. Guidelines provided by RBI Deputy Governor Harun R Khan covering many of the above gaps may serve as a useful starting point.

Many big private sector banks in the western world failed spectacularly during the financial crisis. It is, therefore, essential to question those models as well, instead of treating them as a magic fix. We have to appreciate the historical basis of our own system and find holistic solutions that are fair and prudent. This will only add robustness and longevity to our growth story.


As published in The Economic Times