Urjit Patel’s IBC Panacea For Resolving Bad Loans Puts New Bump On Path To Economic Revival

The Reserve Bank of India (RBI) has both simplified and compounded the bad loans problem of banks. By scrapping all officially sanctioned schemes for hiding loan accounts in default – corporate and strategic debt restructuring (CDR and SDR), scheme for sustainable structuring of stressed assets (S4A), and flexible structuring of existing long-term project loans – it has effectively made the insolvency and bankruptcy code (IBC) the only route for resolving bad loans.

With the Joint Lenders Forum also abolished, and with new norms being set out for reporting defaults, banks will find that they have no blotting paper left to dry the red ink now seeping across all balance-sheets, from the State Bank of India down to lesser banks. Among other things, defaults among entities to which banks have an exposure of more than Rs 5 crore have to be reported weekly, defaults in the range above Rs 2,000 crore have to be resolved within 180 days from 1 March (or 180 days from whenever a future default occurs), and for defaults in the Rs 100-2,000 crore range, separate reference dates will be indicated for resolution.

The RBI notification says that “the resolution plan (RP) may involve any actions, plans, reorganisation, including, but not limited to, regularisation of the account by payment of all overdues by the borrower entity, sale of the exposures to other entities (and) investors, change in ownership, or restructuring”.

The bottomline is this: if there is a default, restructuring will not be possible outside the contours of the IBC. Restructuring is possible only if there is no default. This brings clarity to the process of resolving loans.

At one go, the RBI is thus forcing all banks – and public sector banks, in particular – to give up all “evergreening” practices, and ensure resolutions and haircuts using the IBC. This means the process of recognising and resolving bad loans will accelerate, and probably require even greater capital infusions from the government or the capital markets.

Last October, the government announced a R 2.11 lakh crore recapitalisation plan for public sector banks, of which Rs 88,000 crore is coming by March this year. But if all bad loan resolutions are now going the IBC way, even Rs 2.11 lakh crore will not be enough in the two fiscal years (2017-18 and 2018-19) to enable banks to write off their bad loans, which will now gush at an unprecedented rate.

From all accounts, the losses of many banks may continue all through calendar 2018, making it almost impossible for them to resume lending to finance a growth revival. The cushion of restructuring loans to allow some of them to become good after corporate earnings rebound is thus gone.

Governor Urjit Patel has thus put a crimp in the oxygen pipe that will allow corporates to boost profits and restart the investment cycle. The government’s hopes of reviving growth in 2018-19 may just have gone out of the window.

While all the washing of red ink stains in public is good for transparency, at the practical level it means the RBI is essentially going to play bad boy and slow down the recovery.

The RBI decision has two things to commend itself, but has serious negative consequences too.

The pluses first: banks will have to clean up their acts, and start taking harsh decisions on reducing the overload of bad debts and take haircuts (ie, losses). By removing props like CDR, SDR and S4A, the RBI is forcing public sector bank managements to stop procrastination and risk-aversion while dealing with non-performing assets (NPAs).

However, the IBC is a blunt instrument. As every banker knows, not all loans that go bad stay bad forever, and some can usually recover with the right strategic inputs and economic recovery. As HDFC Bank managing director and chief executive office Aditya Puri observed last July, the IBC should be used as the “last resort” and not the “first thing.” He said: “It (IBC) is a good thing; where a company cannot be turned around you should use insolvency, but that does not mean you take to court every poor fellow who has had an unfortunate circumstance or his business did not work or he needs minor care... you don’t put everyone in the ICU and get a heart transplant”.

While private sector lenders like HDFC Bank can be trusted to make sure that they do not get stampeded into taking every case to the IBC, in the case of public sector banks – where executive autonomy and independence is low – top managers may end up forcing even good projects towards bankruptcy.

The RBI notification tries to address a problem – low willingness on the part of public sector banks to recognise and resolve bad loans due to fear of vigilance inquiries – by making the IBC option the first option.

This can cause needless pain in an already bleeding corporate sector, and also force the government to cough up more capital as public sector banks sink further into the red.

The remedy for the illness is to insulate public sector bankers from excessive scrutiny by crime detection agencies, and/or privatisation. In the absence of either, the RBI is effectively holding a club over bankers’ heads to force them to resolve bad debts at any cost. In a sense, the RBI is providing them an excuse to take risks with resolution, but it is also raising the possibility of a moral hazard where banks take big haircuts citing RBI pressure, causing huge losses to the taxpayer.

In September 2017, the banking sector’s gross bad loans had hit Rs 8.36 lakh crore, of which the public sector accounted for Rs 7.33 lakh crore. Given the spate of huge losses in public sector banks in the December quarter, the total is likely to exceed Rs 10 lakh crore before the financial year is out.

Assuming that banks have, on an average, provided 60 per cent against gross NPAs, we could thus have nearly Rs 4 lakh crore of bad loans that will need provisioning in the months and quarters ahead. The Rs 2.11 lakh crore recap plans for the public sector will be barely enough.

And, yes, the Narendra Modi government may yet come to regret two things: one is its failure to tackle the bank NPAs problem early, and the other is to have appointed Urjit Patel as executioner-in-chief to handle the problem.