Solving The Bank NPAs Mess: Lessons To Learn From CDR

In the past few years, we have had enough and more analysis and commentaries on the state of our banking system and the growing stock of non-performing assets (NPA). Just to explain to the uninitiated, NPA’s are assets from which the banks earn no income and have to provide from their reserves and profits for the losses on account of these assets. Let me explain the issue from the perspective of a commercial banker. Published data shows that the amount of non-performing loan (NPL)s is Rs 6.14 lakh crores as of December 2016 or upto 20 per cent of all loans are NPLs or restructured and therefore NPLs.

Our country, as we all know, is a capital-scarce economy and one of the biggest impediments to growing entrepreneurship is the lack of adequate capital. This extends to all categories of enterprises in the micro, small and medium sector and even to large units in the manufacturing sector. The banking system has been providing debt capital to enterprises for operations, and the central bank has mandated that the “end use” has to be for production of goods or services. The government in its attempt to foster and encourage entrepreneurship has set about some agencies for providing capital to enterprises in addition to the credit assistance available from banks.

The preface on the lack of capital is necessary to understand the reasons for enterprises to face the tag of NPL and the subsequent actions thereof. We have now the Insolvency and Bankruptcy Code (IBC) and the mandate to complete the exercise in a time frame of 180 to 270 days etc. The issue that needs understanding is not the remedial measures available but the labeling of NPA in the first instance.

In the early part of the century, a well thought out process for remedial measures was implemented called “Corporate Debt Restructuring” (CDR) under the aegis of the Reserve Bank of India (RBI) and was to be implemented by a set of commercial banks. Some of our larger enterprises in steel, cement were beneficiaries and have then gone on to achieve larger scales of operations and revenue. One of the main reasons for the success of the CDR scheme was the fact that such accounts were called “Restructured Standard” and were eligible for additional finances from the banking system. This enabled lenders to correct any anomalies in the projections of the business model analysed at the time of grant of credit facilities and helped enterprises to adjust for assumptions made for appraisal of credit requirements for the Banking system.

The RBI, under Governor Raghuram Rajan, decided to “cleanse” the banking system by issuing strict norms for asset classification including for the first time calling restructuring as NPL. In our country, apart from the lack of capital, the other main issue is the unpredictability of our policies and the lack of long duration fiscal policies.

These cause deep unrest in the minds of credit analysts of banks in appraising the requirements of enterprises for credit and therefore result in either under-appraising the requirements or shortening the tenor of loans to combat the threat of NPA under restructuring. This has dealt a blow to enterprises genuinely requiring help due to either disruptive market conditions or policies of the state or central government.

The success of the CDR scheme can be gauged by bifurcating the cases before such an instruction and after. Subsequent schemes like Strategic Debt Restructuring (SDR) or 5/25 or have not met with success because of this one condition. Also while under SDR, banks have been permitted to convert loans to equity, they are handicapped by the Banking Regulation Act 1949, which says that a bank cannot hold as pledge more than 30 per cent of the equity capital of an enterprise.

RBI in its zeal to cleanse the banking system also implemented Asset Quality Reviews (AQR) in all banks. This actually undermines the quality of its own auditors as banks have been subjected to an annual inspection by the RBI every financial year! While on the one hand, it is good to have a “case study” approach to identify the problems, is it not required to be contextual? Should not every solution be dependent or cognisant of the environment? Have we not shot ourselves in the foot by such disclosures of our distressed assets and the subsequent calls to form a bad bank and the like?

The fundamental reason why our Asset Reconstruction Companies (ARC) have not been solution providers is again the fact that they have been lowly capitalised. Instead of addressing the larger issues of infusion of capital in our financial system, finding out such “theoretical” shortcomings have actually pushed us back and yet we bemoan the lack of economic growth in our country. The argument is that in the absence of alternate credit instruments in the domestic financial markets, such unilateral “global” standards have done irreparable harm and made the situation look more alarming than necessary.

In my opinion, for far too long, we have had our central bank staff lacking in the skills set of commercial bankers and an understanding of the “on the ground” situation. Let us understand this, every country manages its monetary policy depending on its macro and micro economic parameters and does not follow the developed countries' model without adjusting for domestic imbalances. In my opinion, Governor Rajan has in no way helped in making our banking system strong; rather created more-than-necessary weaknesses in the system.

As I am not purview to the asset classification in various banks but having been a commercial banker, can safely estimate that bringing back the classification on first time restructuring and ignoring the AQR classifications, the stress assets would be less than half that it is now. In the Indian context, we are survivors and have robust techniques of survival. I am sure given our strong survival DNA, we will weather the situation too in the coming years. I think the government, must after this experience, seriously rethink on “importing” RBI governors, we have enough and more domestic outstanding talent to occupy this office.