This Post is Part-1 of the Addressing Bad Loans series which covers every major scheme introduced in the 21st century in India to address the resolution of bad loans that plague our banking sector. Part-1 covers the developments up until Dr. Raghuram Rajan was the governor of the RBI and Part-2 will cover the interventions made towards addressing bad loans during the tenure of the subsequent governors
Hello,
No context needed here. It is a well-established fact that Indian Banks faced and continue to face problems of bad loans specifically those given by PSBs to corporates. This time I wish to give a comprehensive list of all the major schemes bought out by the Government and the RBI in their efforts to help banks resolve bad loans.
I borrow heavily from “Bad Money” written by Vivek Kaul, “Overdraft” by Dr Urjit Patel and RBI circulars of-course.
First, let’s revise some basics :
What is resolution of a bad loan?
Resolution of a stressed asset is the various measures that a bank might take to help recover the loan amount given to a borrower.
It could involve restructuring, sale of assets of the borrower, change in ownership of the company or liquidation of the company (for example, selling of useful machines of a manufacturing company through an auction)
What is restructuring of a loan?
It involves the change in the tenor (time period) of the loan, changes to the interest rate charged on a loan or a compromise settlement(a one-time payment of an agreed-upon amount).
What is Asset classification?
There are various classifications given to loan goes through before and after it becomes an NPA (bad loan). These terms are what are referred to as asset classification.
Standard: A standard asset is one which is a good loan or at least one which is not declared as a bad loan by a bank.
SMA-0: Loans that have defaulted between 1-30 days
SMA-1: Loans that have defaulted between 31-60 days
SMA-2: Loans that have defaulted between 61-90 days
NPA (Non Performing Asset): Beyond 90 days of default
Sub-Standard: Initially( in most cases) it is classified as Sub-standard and a Bank has to take a loss of 15 % of the loan outstanding for upto 1 year.
Doubtful: Those which remain an NPA beyond a year are called Doubtful and with each passing year the Provision on them increased from 15% to upto 100 %( Doubtful-3)
Loss: Beyond 5 years of being an NPA, the account is classified as a loss account and a 100% provision is required on such loans.
As you read along, you will find that there are multiple interventions that both RBI and the government had made to address the bad loans. An era wise bifurcation of these measures will highlight the varied approaches of the governors of the RBI, the specific circumstances under which these interventions were required and how these interventions faired. They also help in seeing how the actions of the RBI and those of the government complemented or compensated for each other's work, thereby highlighting the cooperation between them. Without such an analysis, there would be no context to the unique problems and needs of each specific era.
Now onto the various actions taken over the years towards the resolution of bad loans.
The Pre-Rajan era
1. Securitisation and Reconstruction of Financial Assets and Enforcement of Security Interest Act (SARFAESI), 2002: The Act empowers the lenders to directly auction residential or commercial properties to recover loans from borrowers.
2. Debt recovery Tribunal, 1993: Debt Recovery Tribunals were set up to facilitate the lenders to recover money from their customers. It was simply an alternative legal setup to exclusively to deal with the recovery of loans that had become NPAs.
3. Corporate Debt Restructuring(CDR), 2001: One of the initial schemes launched to redress the bad loans, through its various circulars in 2001, 2002 and 2005, the RBI allowed for the restructuring of loans. This scheme basically allowed for the restructuring of loans as per the definition given above. However, these restructuring of loans did not have any asset classification impact on the banks, in other words, it was not required for them to be declared as NPAs.
Issues with this approach: The problem with SARFAESI and DRTs is that the Banks have to have some kind of collateral to sell-off. This was most suited for retail loans. But, most of the bad loans that had emerged out of the excessive lending between 2004-2010 came out of project finance loans. Loans that fund infra, power or steel companies and most of these projects had not taken off and so the banks really did not have anything to sell off to recover their debt. Also, CDR was not used much during this time period.
Also a word on Banking itself. Pre-1996, most of the financing was done by government project financing institutions like IDBI, NIDC, etc. In the Mid-1990s came the concept of universal banking, where all banks were expected to participate in all kinds of lending, project financing included. Also, project finance institutions lost most of the privileges given to them. An argument can be made that the lack of project financing know-hows with the traditional banks, had some contributions towards the banks making many inviable big-ticket infra loans given out in the mid-2000s.
The Rajan Era:
Dr Raghuram Rajan took over as the governor of the RBI in September 2013. When he took over as the governor, the major issues that the Indian economy was facing were a fast depreciating Indian rupee and a stubbornly high inflation rate (These are topics for discussion for another time) and the NPA levels were not too high in the banking system. So of course, the initial focus of the governor was to stop the free fall of the Rupee and to bring inflation under check (through a steep hike in the repo rate). It was only after this major crisis was addressed that the real problem facing the banking industry was unearthed. Enter AQR.
4: Asset Quality Review(AQR), 2015-2016: The RBI routinely reviews, on a sample basis, the loan books of banks to see of bad loans are being recognised correctly and if adequate provisioning is being done against them. However, a special team was formed in this time period to investigate many major accounts of the banks. During this process, the RBI made the banks recognise many stressed assets as bad loans and gave the banks a couple of quarters to thoroughly relook their loan books and identify stressed assets and recognise them as NPAs.
Clearly post the AQR exercise, the banks were forced to recognise much more NPAs. In fact, the bad loans recognised were many times higher than what the RBI had expected.
5. Central Repository of Information on Large Credits (CRILC) June 2014: This requires the banks to regularly report all the defaults to the RBI which is accessible across all the banks. This was required because there was no way for other banks to know if a borrower was taking a loan from one bank and refinancing their loans with another bank. In an effort to improve information sharing between banks about defaulters and to plug this information asymmetry, CRILC was introduced. This was not exactly a measure to resolve bad loans but to improve coordination between banks to end refinancing of loans.
6. Joint Lender’s Forum (JLF), February 2014: If CRILC was an effort to help solve information asymmetry problem between banks, JLF was an effort to improve the coordination between banks to resolve the bad loans for loans that were offered by multiple banks to the same borrower either individually or in a consortium arrangement. This required all the borrowers to form a forum for the defaulted loans and have a resolution plan in place with the approval of 75% of the lenders by the value of the loan and 60 % of the lenders.
7. Restructuring not possible unless declared as NPA, April 2014: Now this is one of the most important steps taken by the RBI. Before this, Banks were allowed, as part of the resolution plan to restructure the loans without declaring them as bad loans. The intention behind such functioning was that the majority of the bad loans were in the power, steel and construction businesses. Declaring these loans as NPA would have an adverse impact on the projects themselves and thus important infrastructure needed for nation-building would be delayed. But, the unintended negative externality of this scheme was that the crony capitalists who had influence could just get their loans restructured with better terms and even the Banks got away by not declaring them as NPAs, creating a win-win situation for both. The RBI saw that these are stressed assets which were just not getting recognised as NPAs. This step of recognising them as NPAs put an end to just keep restructuring the loans. After AQR policy recognitions of bad loans in India surged as many such loans came to fore.
8. Strategic Debt Restructuring (SDRs), June 2015: This allowed for the lenders to become investors in the project by converting a portion of their debt to equity. This would help Banks get a seat on the projects strategic decisions to drive the projects, and at a future date, sell their portion of equity at a profit (hopefully) and recover the money.
9. Scheme for Sustainable Structuring of Stressed Assets (S4A), June 2016: Similar to SDR, but the RBI allowed Banks to convert up to 50% of their debt to equity. Also it allowed the promoter of the company to continue to manage the project even if he/she were the minority shareholder after transferring equity to the Banks. I guess this was bought in as the expertise of the Banks is lending and not particularly in managing how a road is laid or a power plant is installed. Also, if the promotors were no longer in management, their skin would not be in the game and the projects would be inclined towards failing. Therefore, by continuing the promoter to remain in the driver’s seat, the RBI hoped there would be more likelihood of these projects actually completing and hoped the Banks would recover their money.
10. Asset Reconstruction Companies (ARCs), though started in 2002 mainly used between 2010-2017: RBI encouraged the setting up of private buyers of Bad loans. These companies would buy these loans from the lenders and then pursue the recovery of these loans form the borrowers. The idea was that the banks would be freed to pursue their basic business of lending and the headache of recovering them would fall on the ARCs.
There were multiple problems with this, first, the bad loans would still remain the in the system, though not with the original Bank, second, the ARCs would still have to go through the traditional recovery process through DRT or SARFAESI to recover these loans which had proven to be ineffective in the recovery. Another issue was that ARCs would typically not have money upfront with them to pay to the banks when taking over the loans and would instead issue securities (like Bonds) which promised payment at a later date and so there was no immediate cash recognition after selling these loans. The Banks had to continue holding provision on these loans anyway. Ultimately this scheme has not resulted in a major success for resolution of NPAs and very few small-ticket loans for which ARCs could pay upfront in cash to the Bank are taking place nowadays.
11. Flexible refinancing and repayment option for long-term infrastructure projects aka, 5:25 scheme, February 2014: In short, this allowed the Banks, for specific infrastructure projects, to extend long-term loans of 20-25 years to match the cash flow of projects, while refinancing them every five or seven years. Typically Banks would not lend beyond 10-12 years. But due to various delays in the clearances of the projects, the timeline of execution of these projects had extended. In order to allow Banks to wait for the projects to be completed. In return getting paid through the cash flows from these projects, this scheme was envisaged. This was an attempt to ease the stressed cashflow of these projects.
Rajan Era Summarised:
The major changes we see during the Rajan era include in recognising the stressed assets as NPAs. I remember him repeatedly telling in press conference after press conference that the stressed assets are to be recognised as bad loans. If not, then down the line, the bad loans with the Banks will balloon up cause massive financial stress to all the banks with severe capital inadequacy.
The other major intervention in the Rajan era was that due to the lack of a legislation from the government, the RBI was trying to put in place many schemes to help Banks resolve these bad loans. Majority of the schemes were with an aim to help bank refinance, restructure or to convert debt to equity in the loans. These schemes, more of experiments, were not hugely successful as they were majorly stop-gap arrangements due to the lack of a corporate bankruptcy procedure in the country. It was the government’s turn to step in and institutionalise a bankruptcy procedure.
Need for an Insolvency & Bankruptcy Code (IBC):
Winding up of businesses was practically impossible in India due to multiple legal, regulatory and bureaucratic requirements. Ideally, favourable conditions for setting up of companies get a lot of policy thinking space in the country. Similarly, a procedure for winding up a company should be available to assist in the transfer of capital and labour from the failed company to a more productive and efficient one. Due to the socialistic hangover from the past, a company going bust is generally seen as a bad thing by the government and needed many approvals and settlements for it to happen. Hence, precious capital and labour continue to be invested in unproductive ventures.
An IBC was needed to improve this, to allows companies to fail and wind up fast. The IBC was operationalised in India from June 2016 with an audacious stipulated time from settling cases within 180 (Later extended up to 330 days) while insolvencies before this took over 4 years to be processed.
As the IBC became operational, Dr. Rajan demitted the office of the Governor of the RBI.
How did the IBC change the regulations with respect to the resolution? What were the approaches taken by Dr. Urjit Patel and then Mr. Shaktikanta Das? And how did they fair? These questions and more will be addressed in Part-2 of the post which will be out later this week. It only gets interesting from here!
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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