Newly-appointed Reserve Bank deputy governor Viral V Acharya today called for some urgent steps to resolve NPAs, saying none of the "piece-by-piece approach" offered so far has worked, including the AQR, simply because of "the many discretions given to banks" as also their "skewed incentive system".
He also said even the December 2015 asset quality review (AQR) by the central bank has not helped resolve the issue, except in turning public attentions to the same.
Stating that timely resolution of NPAs is of essence if we were to restore corporate investment and create jobs, Acharya asked bankers to take NPA resolution "with a certain sense of urgency."
"I wish to speak today, with a certain sense of urgency, about the need and possible ways to decisively resolve our banks' stressed assets," he said in a speech 'Some ways to decisively resolve banks' stressed assets,' delivered at an IBA event here this evening.
The noted economist who joined the central bank only last month from New York University, noted that since asset quality review of December 2015, up to a sixth of public sector banks gross advances are stressed (NPAs, restructured or written-off), and a significant majority of these are in fact NPAs and for banks in the worst shape, the share of assets under stress has approached or exceeded 20 per cent. This estimate of stressed assets has doubled from 2013 in terms of what had been recognised by banks.
Pointing out that the doubling of bad loans was not overnight, he said "there have been several hints - in the declining price-to-book ratios of bank equity, and in the many assets "parked" by banks under the CDR Cell were severely stressed. These assets were deserving of advance capital provisioning against future recognition as NPAs."
"Though the AQR has taken a massive stride forward in bringing the scale of the problem out in the open and stirring a public debate about it, relatively little has been achieved in resolving the underlying assets to which banks had lent," Acharya rued, adding similar was the fate of the several resolution mechanisms and frameworks offered by RBI as progress has been painfully slow.
He also traced the roots of the present problem to the breakneck lending during the heydays of 2009-12 period, when the economy was racing ahead, which left the companies laden with high levels of bank debt to such a level that their interest coverage ratio has fallen even below one with no capacity to raise funds for working capital and capex, and the original promoters' inclination to part no money but only sweat equity.
Acharya said, original promoters who rarely put in any
financing and primarily provide sweat equity have had somewhat of a field day, facing limited dilution of their initial stakes nor much of a threat of being outright replaced.
"There is a connection between these two outcomes - the lack of a comprehensive recognition of stressed assets by banks and the absence of any resolution.
"Both stem from the structure of incentives at our banks and the fact that stressed assets have been an outcome of excessive bank lending, en masse, in a relatively short period from 2009 to 2012, and to a concentrated set of large firms in a number of sectors such as infra, power, telecom, metals (iron & steel, in particular), EPC, and textiles," he said.
Noting that most of our NPA resolution worked like "kicking the can down the road and leaving them as legacy assets for the next management team to deal with" Acharya blamed this to the incentive system in our banking system.
"Only a bank that fears losing its deposit base or incurring the wrath of its shareholders is likely to recognise losses in a timely manner. But in many of our banks, such market discipline is simply not present at the moment.
"In others, even if some such discipline is at work, banker horizon is too short until end of the CEO's term. Banks lobby for regulatory forbearance, perhaps some loan prospects turned sour due to bad luck, but beyond a point, concessions in recognising losses just ends up being a strategy of kicking the can down the road and leaving them as legacy assets for the next management team to deal with," he said.
On top of this comes the sectoral concentration of losses he noted. "Given the scale of assets that needs restructuring, it is natural that the turnaround capital at ARCs has been limited in comparison. Some capital is simply sitting on the fence until serious asset revamp happens.
"The loss of capital that will result on banks' books and the fear of vigilance actions that such haircuts might trigger have made it almost impossible to get banks to embrace restructuring," he noted.
Admitting that there is no right price at which the market for stressed assets clears if left alone to private forces, he said even with an orderly resolution mechanism under the new Insolvency and Bankruptcy Code, there is no reason for banks rush to file cases.
This, he said incentivises the ARCs to "just asset- strip rather than do the economic turnaround," as assets are bought at steep discounts. "And all this is playing out to near perfection in our setting. Its consequences are pernicious," Acharya warned.
"At one end, public sector banks are running balance- sheets that seem to be in a perennial need of recapitalisation by government, and shying away from lending to potentially healthier industrial credits," he rued.
Warning that recovery is a long way off, Acharya said
sectors with the most stressed assets have so much excess capacity relative to current or near-term utilization that there is no sign of a pickup in higher capacity utilisation.
Noting this has forced "promoters to stay afloat with rollovers from banks which only increase their indebtedness, partly disengaged, partly disgorging cash from the few assets that are running," he warned that "the end result is the silent atrophy of the true potential of these assets."
Warning that this present situation is a cause for deeper concern to all of us, he said "it is reminiscent of weak banks and stagnating growth seen 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."
Stating that we are at "a crossroads and have an important choice to make," he warned "we can choose the status quo, but this would be insanity. It would risk a Japanese or an Italian style outcome."
"Or we can choose to call a spade a spade as Scandinavia did to resolve its banking problems in the early 90s and the US did from October 2008 to June 2009, even if only after letting a significant bank fail.
He went on to warn that "with our healthy current level of growth and future potential, with our hard-fought macroeconomic stability, with our youth climbing echelons of entrepreneurial success day after day, with our vast expanses of rural India that need infrastructure and modernization, and with our levels of poverty that have steadily declined but still need substantial reduction, we simply don't as a society have any excuse or moral liberty to let the banking sector wounds fester and result in amputation of healthier parts of the economy."
Suggesting some ways to effectively resolve the bad assets issue, Acharya said first there has to be an incentive provided to banks to get on with it and restructure the stressed assets at a price that clears the market for these assets. If they don't do it in a timely manner, then the alternative should be costlier in terms of the price they receive.
Secondly, the ultimate focus of the restructuring and the pricing must be the efficiency and viability of the asset as generating the best price for the bank at all costs may only result in cosmetic changes and risk serial non- performance of the assets.
Thirdly, the government should not be footing all the losses bank book from bad asset sale. Wherever possible, private shareholders of banks should also be asked to chip in.
