In the midst of raging controversy over the Citizenship Amendment Act [CAA] [2019] and fear over the impending National Register of Citizens [NRC] capturing headlines in the media, a positive news for the economy went unnoticed. This relates to improvement in the health of the banking system.
According to the annual report on ‘trends and progress of banking in 2018-19’ released by the Reserve Bank of India [RBI], the gross non-performing assets [GNPA] – a euphemism for loans turning dud – expressed as percentage of total loans declined from a high of 11.2% during the financial year [FY] 2017-18 to 9.1% during FY 2018-19. During the current year, this has remained stable at 9.1 per cent as of September-end, 2019. Correspondingly, the net NPAs declined from 6% during [FY] 2017-18 to 3.7% during FY 2018-19.
The improvement was led primarily by public sector banks [PSBs]. Their gross NPAs declined from 14.6% during [FY] 2017-18 to 11.6% during FY 2018-19. Correspondingly, net NPAs stood decreased from 8% during [FY] 2017-18 to 4.8% during FY 2018-19. During the same period, private sector banks’ GNPA deteriorated from 4.7% to 5.3% [but, this was due to the massive NPA pile of IDBI Bank, which after the takeover by LIC effective January 21, 2019 is now classified as a private sector lender; excluding IDBI Bank, GNPA for private banks actually declined]
This has been made possible by ‘speedy resolution’ under the Insolvency and Bankruptcy Code [IBC] enacted in December 2016. Modi – government also amended the Banking Regulation Act [BRA] [2017] arming the Reserve Bank of India [RBI] with powers to give directions to banks for referring NPAs to National Company Law Tribunal [NCLT] for resolution of under IBC.
On February 12, 2018, the RBI issued an order requiring that in respect of accounts with aggregate exposure of the lenders at Rs 2,000 crore and above, as soon as there is a default in the borrower’s account with any lender, all lenders – singly or jointly – shall initiate steps to cure the default. The resolution plan [RP] – approved by all lenders – has to be readied within 6 months from the date of default. If, the deadline is missed, the case is referred to NCLT who gets 6 months to complete the resolution process. Under the circular, thus far, over 70 accounts involving NPAs worth about Rs 380,000 crore were referred.
Meanwhile, following an order of the Supreme Court [SC] on April 2, 2019 quashing the above circular, on June 7, 2019, the RBI issued a revised circular on resolution of stressed assets. Under it, from the day a loan account is in default, the lenders get 30 days [also referred to as ‘review period’] to enter in to an inter-lender agreement to put in place a resolution plan [RP]. The RP shall provide for payment not less than liquidation value [estimated realizable value of the assets] due to the lenders. An agreement signed by lenders representing 75 per cent by value of outstanding or 60 percent of lenders by number would be binding on all lenders.
Further, to ensure that banks stick to the timelines, the circular requires them to make an additional provision of 20% if RP is not implemented within 180 days [from the completion of review period] and a further 15% if it is not implemented within 365 days from completion of review period [this means a total of 35% if RP is not done within 365 days]. These provisions will be over and above the ageing provisions that banks provide once the asset turns non-performing.
The accelerated provision boils down to mind-boggling provisioning requirement. If, there is no resolution within one year from default, it will attract provision of 50% – 15% normal ageing provision and 35% additional provisions. Similarly, at the end of 15 months, the total provisioning requirement will be a steep 75 percent – 40 percent normal ageing plus 35 percent additional provisions. Such high provision requirement will nudge banks to refer cases to NCLT, if no resolution is in sight within prescribed timeline.
In case, the resolution is eventually pursued under IBC, 50% of the provision would get reversed on filing of insolvency application and the remaining half on admission of the borrower into the insolvency resolution process under IBC.
Earlier, if a company was not doing well and unable to pay back [including cases of willful defaulters], there was no way the lenders could recover the loan. This led to capital erosion and impaired the ability of banks to lend. With IBC, all this has changed. The banks can now drag defaulting borrower to the court and recover the money in a time bound manner. The drastic improvement in the NPAs scenario as brought out in the RBI report bears ample testimony to the success of this revolutionary reform.
Meanwhile, the government has made several amendments in the IBC to prevent misuse of the mechanism by dubious defaulter/promoters on the one hand and give comfort to the potential acquirer on the other. There are provisions to ensure that the defaulter does not end up acquiring the asset through the backdoor at a discounted price. From the acquirer’s perspective, the Code has been amended to ensure that the assets are not encumbered by agencies such as the Enforcement Directorate [ED]. Further, he will be shielded from criminal proceedings – initiated against original promoter/company.
The ambit of stressed asset resolution under IBC has been expanded to cover non-financial creditors such as home-buyers. This gives them an opportunity to initiate proceedings against project developer and either get homes or their money back. Recently, amendments were also made to bring non-bank finance companies [NBFC] under its purview. This will help in addressing the crisis facing this segment due to the failure of Infrastructure Leasing and Financial Services [IL&FS] and Dewan Housing Finance Limited [DHFL] to honor their liabilities running in tens of thousand crore.
To sum up, the government has put in place a robust institutional framework to resolve stressed assets of banks, NBFCs as also operational/non-financial creditors including home-buyers in a time bound manner. It not only provides an efficient mechanism for extracting maximum value after a loan has turned dud but also help in preventing such a scenario. This is by instilling a sense of fear in the mind of borrower that he could lose control of the company [if he defaults in servicing the loan] as also by making the bank more careful at the time of lending and monitoring the fund use.
The IBC framework can be a springboard for making our lending institutions healthy and robust. This in turn, will enable them lend more at lower interest rate thereby giving a boost to investment as well as generating demand [much of the current slump in automobiles, consumer durable etc is due to the mess in NBFCs hampering their ability to lend]. It can be a potent instrument for putting Indian economy on a high growth trajectory.
However, to get the intended results, it is imperative that the current pace of governance reforms in PSBs continue. It will require that banks enjoy full autonomy in their working and that there is no political or bureaucratic interference. The banks must ensure that they don’t revert to the indiscriminate lending seen during 2004-2014 [a good portion of that was so called ‘phone banking’]. Ideally, Modi should work on reducing government’s shareholding in PSBs to below 50% so that even when there is change of guard, the political brass can do little to interfere in their working.
The banks should also avoid indiscriminate lending to small and micro enterprises. A case in point is loans given under the Pradhan Mantri Mudra Yojana [MUDRA]. Under MUDRA, banks provide loans up to Rs10 lakh under three categories depending on size viz. Shishu: loans up to Rs 50,000/- ; Kishore: Rs 50,000-5 lakh and Tarun: Rs 5-10 lakh. According to MUDRA’s annual report, NPAs under the scheme was 5.38% as on 31 March 2018 [the position is likely to deteriorate further during 2020-21 after the existing forbearance on restructuring of loans to small businesses allowed by RBI expires]. This is because in their over-zealousness to achieve target [loans for total value of Rs 5.57 lakh crore were given under 12.27 crore accounts] banks gave loans without conducting due diligence and assessing repayment capacity of borrowers. This must be avoided.
The banks should also stop playing second fiddle to state governments who having made promise in election, ask them to waive loans to farmers without giving them the money. The former must not waive loans unless they receive funds in advance from latter. The banks should maintain arms-length distance from both the centre and states.