Addressing Bad Loans - Part 2
This covers the Major interventions during Dr Urjit Patel and Mr Shaktikanta Das's tenure as RBI Governors to address the NPAs in the Banking system. What went into making those decisions? Read on
In Part-1 we covered the interventions made by the regulators and the government up until Dr. Raghuram Rajan was the Governor. He had to put in place a lot of Ad hoc schemes as there was no IBC institutionalised by the parliament. Just before he left the office, the IBC was made operational. How did the regulator use this new tool to address the bad loans? Let's find out.
The Urjit Era
Dr Urjit Patel took over the reins as the RBI governor in September 2016. The NPAs were climbing exponentially with the ongoing AQR exercise. Also, the new Insolvency and Bankruptcy had been passed by the parliament and become operational just months before.
12. Insolvency and Bankruptcy Code (IBC), towards the recovery of bad loans (A brief on IBC was covered in Part -1):
In the context of resolution of bad loans, the IBC provided for a time-bound resolution of companies that go bust. In the IBC process, the company is sold to another company, at a discount. The proceeds of this sale could recover banks loan. This resolution plan should be approved by the lenders and by special courts set up to enforce the IBC (NCLTs).
If there is no resolution (no takers for the defaulting company) within the specified timelines, the company will be liquidated. The proceeds of this liquidation are then split-up among each of the lenders.
A major problem for the borrowers was that they would lose their company incase the banks went to the NCLT to recover their dues. The borrowers fear of losing their company would bring a lot more discipline in clearing the dues with the bank through better co-operation.
13. Prudential Framework for Resolution of Stressed Assets V1.0, February 18, 2018,
This was Big!
In its circular, the RBI stated that even if it’s a default of a single day by a company, it’s lending Bank either individually or with all other lenders must start working on a resolution plan. And, within 180 days, such a resolution plan must be in place, failing which the Banks have to immediately take it up with NCLT under the IBC.
About 28 other schemes that were in place till then like S4A, JLT, SDR were discontinued with immediate effect.
In case a restructuring is proposed as a resolution, the account is to be immediately classified as an NPA. And, only after a satisfactory performance under the new restructured arrangement over a period of time (till up to 10% of the outstanding is paid), can the asset classification be revised to standard.
What was RBI’s logic to initiate a resolution plan right from day 1 of the default?
The RBI said that since the default is a “lagging indicator” the Banks should be more vigilant and should be able to pick up these cases even before they default. So, no additional time was given for them to act on these cases.
Why were other schemes discontinued?
Since most of the schemes launched during the Rajan era were seen as stopgap arrangements in the absence of a concrete Bankruptcy code. With IBC in place, these schemes ran their course.
The RBI also felt that since the government had stepped in for the timely resolution of stressed companies (330 days timeline to decide a case in NCLT), by fixing a timeline of 180 days for the execution of a resolution plan, the RBI was streamlining its resolution guidelines to be time-bound too.
Say a company had defaulted, within 180 days a resolution plan is to be put in place, failing which it would move to NCLT. Next, the NCLT is to decide the case within 330 days or the company would be liquidated, therefore giving the Bankers visibility of the timelines to look at for resolutions.
Another reason given behind these strict times lines was that as resolutions get more and more delayed, the assets get degraded and at the end when all the formalities are done, there won’t be any interested buyers of the company.
Another important point was that in PSBs the heads of the banks hold the post for a brief time do not want to get into a lot of trouble by recognising too many bad loans and taking too many far-reaching decisions. So, these banks would find shelter in one of the many schemes or legal proceedings thus delaying the resolution process and leaving the mess for the incoming head of the bank to deal with it.
Also with many options available, there is the element of crony capitalism where powerful people could get their way. But when the Feb 18 circular struck down all the other resolution processes, the banks had no choice but to come up with a resolution plan in 180 days or go to NCLT.
This was a way the central bank was trying to nudge the PSBs to act on the resolution of the bad loans. In a way by tying the hands of the Banks, the RBI freed up the officers in PSBs to proceed boldly with resolution as they had no other choice but to do the only thing that was permitted in terms of recovery of these loans.
SC strikes down this circular:
The Supreme Court of India found this circular to be ‘unconstitutional’ and stuck it down. It said the RBI could not ask banks to move cases to NCLT and can only do so on the union government’s directions for specific cases.
Shaktikant Das era:
By the time Mr Shaktikanta Das had become the governor of the RBI December 2018, the February 18 circular was sub-judice and the economy had started to show signs of slowing growth, with inflation majorly under control. On the other hand, the MSMEs were badly impacted due to the demonetisation and the GST rollout. Also, to make things more challenging, the economy was hit by COVID-19 in March 2020 leading to us currently facing an impending recession.
14. Prudential Framework for Resolution of Stressed Assets V2.0, June 7, 2019:
With the SC striking off the Feb 18 circular, the RBI came up with a new circular on the resolution of bad loans.
In this circular, RBI gave a 30 day (review period) for the Bank (earlier 0 days) to decide if it wants a resolution plan or to initiate legal action against a borrower. And this resolution plan had to be put in place within 180 days. All older schemes, like in V1.0 still stood cancelled. There were 2 other major changes,
One: a form of JLF( Joint Ledger Forum) was introduced, it was called the inter creditors agreement (ICA). The Feb 18 circular had allowed for the banks to have their individual resolution plans with the borrowers, but now, within those 30 days of the review period, the borrowers had to enter an ICA. Also for a resolution plan had to be approved by 75% of the lenders by the value of the loan and 60 % of the lenders.
Two: If there was no resolution plan in place at the end of 180 days, the lenders just had to make an additional provision (loss) on their P&L of 20% for a year and 15% the following year. The rules for restructuring were similar to those in the Feb 18 circular.
Clearly, this was a major departure from the aim for a time-bound resolution of the NPAs. The only problem with not having a resolution plan in place was an additional provision that the banks had to make, which the Banks would anyways make when the due to ageing of the bad loan. But with the Supreme Court ruling that RBI could not force banks to go to NCLT unless suggested by the union government, all the RBI could do was ask banks to have additional provision and hope that it was a disincentive enough for banks to hurry up the resolution process.
15. Restructuring of SME Loans up to Rs. 25 crores, 2018:
India has been experiencing economic slowdown since 2017 or so. Also, demonetisation and it’s implementation had an impact on businesses, especially MSMEs. The RBI had allowed for a one-time restructuring of MSME loans up to Rs. 25 crores. The window for this to be implemented was up to December 31, 2019. Then in early 2020, this deadline was extended till December 31, 2020, and then to March 31, 2021. These restructuring would not be required to be reported as NPAs, a major concession. The union government, which is the principal shareholder of PSBs, had asked its bank last year to not recognise any bad loan and use this scheme to instead restructure settled MSME loans. It's in a way a return to the old methods of not recognising bad loans on time and brushing them under the carpet.
16. Prudential Framework for Resolution of Stressed Assets V2.1, August 6, 2020:
A special window under the June 7, 2019 circular for those borrowers who are impacted due to COVID. It allows for resolution of all the borrowers who have been ‘impacted’ by COVID are on default for less than 30 days till March 1, 2020. The banks can invoke this facility till December 31, 2020. These resolution plans are not to impact the ownership of the companies and also if there is any restructuring that is being done, then they do not have to be classified as NPAs and can continue to remain standard. So, in short, we will see a surge in the restructuring of loans which fall into the eligibility criteria in the coming quarters. An expert committee, whose report is expected in the 1st week of September has been set up to decide on the limitations or the boundaries of these resolution plans like what kind of haircuts the banks can take, by how much the tenor may be extended or how much the interest rates can be altered.
This only complicates the entire restructuring process with too many compliance issues. In the Book "In Service of the Republic", the authors argue that one of the ways of handling a negative externality due to a market failure, if any, is to enable two private entities to enter into an agreement on how to resolve them. It says, "When Property Rights and contract enforcement work well, private persons will negotiate their way to many good solutions."
The book also talks about how most of the state intervention is coercive in nature and its interference should be minimum. Instead, it should focus on creating the mechanisms that allow private players to quickly resolve differences in case of disagreements without dictating the terms of the contract. The expert committee, setting the boundaries for the resolution processes is an example of coercive action by the state and the outcomes may not be optimal if allowing for the easy restructuring of the loans is the goal of the RBI.
In a subsequent post, I will pick up more ideas on the many frameworks of policy I learnt from "In Service of the Republic" and explore how regulation of banks can be less coercive and have better outcomes for the society.
Regards,
Bheem
Disclaimer: All the views expressed above belong solely to the author, and do not represent those of the organisation of employment.
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