RBI's revised framework for resolution of stressed assets will crimp growth

Enough of crony capitalism — that seems to be the tough message of the Reserve Bank of India’s (RBI’s) Revised Framework for Resolution of Stressed Assets released on February 12.

The RBI has scrapped the various schemes introduced over the years, such as Corporate Debt Restructuring, 5/25 Refinancing of Infrastructure, Strategic Debt Restructuring, and S4A. These were all ways of “kicking the can down the road”, that is, giving more time to promoters to make their companies or projects viable while keeping provisioning costs low for banks. The RBI seems to have concluded that these have not delivered — they only enabled promoters to retain control over assets while imposing heavier costs for banks at a later point. 

Under the revised framework, bad loans are to be more quickly recognised and provided for. From March 1, for all loans above Rs 20 billion, resolution must commence within 180 days of default. Where banks and borrowers cannot agree on a plan within 180 days, resolution will happen under the aegis of the National Company Law Tribunal (NCLT). The defaulting promoters will stripped of ownership and control. Their assets will be sold to the highest bidder or simply liquidated. 

The RBI is administering strong medicine to rid the banking system of the non-performing assets (NPAs) problem at one go. This is a laudable objective. However, the RBI must ensure that the medicine does not kill the patient. Resolution is best effected when economic growth is buoyant. Borrowers then have a better chance of returning to health and repaying loans. Lenders are better placed to absorb losses. The revised framework runs the risk of undermining the ongoing economic recovery and hence worsening the NPA problem in the very process of resolving it.

Why so? First, NPAs and provisioning in the banking system are bound to rise as more stringent norms kick in. Most of the Rs 1.53 trillion that public sector banks (PSBs) will get from the government over two years under the recapitalisation plan could end up being absorbed by provisions — and more may be required. There will be no capital to support credit growth. 

Secondly, 180 days is too short a period for achieving resolution. The RBI could argue that banks have had enough time over the past two or three years to achieve resolution. But, then, banks lacked the capital to take the hair cuts on loans required to restore viability to projects. The present bank recapitalisation plan should have happened three years ago. Delayed resolution is largely the result of delayed recapitalisation. After providing capital belatedly, expecting bankers to arrive at resolution in 180 days’ time is a bit thick.

Thirdly, the requirement that all bankers should agree on resolution is unrealistic. The RBI must modify the stipulation to state that banks that account for, say, 75 per cent of the exposure must agree. Else, very little resolution may happen at the bankers’ end. 

Fourthly, while banks are now free to do whatever it takes to achieve resolution, the old problem remains. Which public sector banker will take large write-offs of loans and risk investigation after retirement? The framework requires resolution proposals to get at least an investment grade rating from rating agencies. How does a banker decide whether he should get a minimum acceptable rating with a low write-off or a better rating with a high write-off?

The cumulative result of factors two, three, and four above will be that the vast majority of bad loans will head for the NCLT. This is bound to clog up the NCLT system. Besides, the NCLT process is yet to be tested. For the sale of assets to be worthwhile for banks, we need a large number of bidders. That is not the experience we have had in the assets so far put up for sale. There are reports of waning interest amongst foreign bidders. 

As more and more assets come up for sale, there is every prospect that bidders will dry up. If there are no bidders, assets would have to be liquidated. This would be a disaster for banks — liquidation will fetch them very little. It would also be a tragedy for the economy — huge infrastructure assets that are stalled will amount to nothing. 

Growth is the best elixir for an NPA problem. In the early 2000s, India had an NPA problem that was just as bad. We resolved it by growing our way out of it. Large projects that have been stalled for want of funds are an important factor constraining growth in recent years. So is inadequate growth in credit to the MSME sector.

Bank recapitalisation was supposed to be the key to reviving credit growth. In his Budget speech, Finance Minister Arun Jaitley claimed that the recapitalisation bonds of Rs 800 billion issued in 2017-18 would lead to additional credit of Rs 5 trillion. The markets cheered because they thought PSBs would grow credit and profits.

What’s happening on the ground is quite different. Eleven PSBs have come under Prompt Corrective Action (PCA). The finance ministry has given some of the PCA banks targets for shrinking their balance sheets in the next couple of years. The stronger PSBs, including State Bank of India, have already been hit by rising provisions. The RBI’s revised framework spells even higher provisions and poor recovery for banks. Credit growth cannot possibly revive under these conditions. 

Over the past two years, demonetisation and the introduction of the goods and services tax created short-term disruption while promising long-term gain. Another policy-induced disruption is the last thing we need in 2018-19. The RBI must re-examine its revised framework. The government must plan for higher capital infusion into PSBs and rethink its idea of shrinking some PSBs.

The writer is a professor at IIM-Ahmedabad ttr@iima.ac.in