Management of Banks' NPAs: The Global ANALYST, June 2017

The Global ANALYST, June 2017

Management of Stressed Bank Assets*:

It’s Time for Action

M G Warrier, Ex-GM, RBI

“All countries have central banks, and some countries also have additional financial supervisory authorities with designated functions. These agencies are responsible for ensuring compliance with their rules and regulations, and thereby encouraging ethical behavior in dealings between banks and their borrowers and depositors. While rules and regulations as well as periodic inspections are necessary parts of the regulatory framework, the supervisory system in many countries has become overloaded, and is also highly bureaucratic an discretionary…”

-Bimal Jalan, former RBI Governor

“The financial sector is, in many ways, the brain of a modern economy. When it functions well, it allocates resources and risk efficiently and thereby boosts economic growth while also making lives easier, safer and more fulfilling. It broadens opportunity and attacks privilege. It works for all of us. Of course, when it works poorly, as it has done recently, it can do enormous damage while benefitting a very few.”

-Dr Raghuram Rajan in his book ‘Fault Lines’ (2010)

Recalled the above observations in the context of the challenges before Reserve Bank of India in the context of a surgical procedure which the central bank has been ‘mandated’ to oversee, to restore the health of the Indian Financial System.

Putting the ‘Act’ together

On May 4, 2017, President of India gave his consent to an Ordinance amending the Banking Regulation Act, 1949 enabling Reserve Bank of India to initiate certain fresh measures for resolution of stressed assets in the banking system. The Banking Regulation (Amendment) Ordinance, 2017 inserted the following two sub-sections, after section 35A in the Banking Regulation Act, 1949:

35AA. The Central Government may by order authorize the Reserve Bank to issue directins to any banking company or banking companies to initiate insolvency resolution process in respect of a default, under the provisions of the insolvency and Bankruptcy Code, 2016.

Explanation - For the purposes of this section, “default” has the same meaning assigned to it in clause (12) of section 3 of the insolvency and Bankruptcy Code, 2016.

35AB. (1) Without prejudice to the provisions of section 35A, the Reserve Bank may, from time to time, issue directions to the

banking companies for resolution of stressed assets.

(2) The Reserve Bank may specify one or more authorities or committees with such members as the Reserve bank may appoint or approve for appointment to advise banking companies on resolution of stressed assets.’

Role of RBI

Since independence, RBI has been performing several roles which are not assigned to Central Banks elsewhere in the world. The present Ordinance doesn’t add much to the regulatory powers or responsibilities, but will serve to tell the stakeholders that GOI and RBI are on the same page, at least on the management of stressed assets by banks. RBI Act together with the pre-ordinance B R Act confer enough powers on RBI to regulate and supervise Banking System.  Problems, including the present one relating to stressed assets emanated from back-seat driving by Finance Ministry using "ownership rights" both that of RBI and PSBs. Trespass into internal functioning including credit decisions and HR issues by finance ministry during the 10 years ending FY 2014 has done irreparable damage to the functioning of RBI and PSBs. Unusual situations call for unusual policy decisions. Ordinance should be seen in this perspective.

According to some interpreters, the NPA ball has been kicked back to RBI’s court. Let us take on record that the above Ordinance doesn’t differentiate between public sector banks and private sector banks. And, it would be foolish to comment on the brief amendments to B R Act carried out through the Ordinance, in isolation.

Experts’ view

These days, sane pieces of advice on policy, which are not guided by constituency interests, are  a rarity.  But, an interview with Deepak Parekh, Chairman, HDFC  captioned ‘RBI has to ensure NPAs are not swept under the carpet’ published in a mainstream financial daily (Business Standard) on May 16, 2017  proves that there is still scope for hope and there will be appreciation from those who understand things, if policy makers and regulators move in the right direction.

The brief answers from the veteran banker, to the pertinent questions raised by Joydeep Ghosh should set at rest the apprehensions raised by economists and the analysts in the media about the purport of the Ordinance amending the B R Act and the role of RBI in the resolution of NPA crisis.

Post-Ordinance debates strayed away from the main issue of managing stressed assets of the banking system and were sometimes judgmental   about the modalities to be followed and the role of GOI and RBI in supporting the banks to get out of a crisis created by policies which compromised prudent principles of banking for political and administrative expediency.

Deepak Pareekh has done a service to the future of the Indian Financial System by making the following observations:

a)    ‘It is a pointless debate over whether banks are giving up their autonomy or whether the RBI or the government will be micro-managing the situation….it is the job of the regulator to ensure stability in the system.’

b)    ‘With the benefit of hindsight, it (RBI being aggressive on the asset quality review) was the right decision as the AQR brought out the extent of toxic assets in the system. Where the central bank needs to firmly stand its ground is putting an end to the practice of sweeping NPAs under carpet. This, above all, is an issue of governance.’

All blame on PSBs

Public sector banks continue to remain the whipping boy for the non-performance of assets created in the private sector. The context in which they came into existence in the first place, and the reluctance of residual and new private sector banks to finance social or priority sectors or even look at clientele below a certain threshold levels they arbitrarily fix or open shops in semi-urban and rural areas.  

All through, the comparisons have been the percentages of gross and net NPAs accumulated in ‘public’ and ‘private’ sector banks and ‘market valuation’ of the two categories of banks. Rarely one reads anything about the context of formation of State Bank of India, Bank Nationalization, current business mix or share in banking business held by the two categories of banks. Remember, both categories of banks are sourcing their resources from public deposits and are expected to serve the same clientele.

RBI initiative

Stricter and prudent classification of stressed assets at the instance of RBI doesn’t change the health of such assets. If PSBs are to continue to perform the role expectations of nationalization, they need a level playing field in choice of clientele, area of operation, sectors to be financed and more importantly in managing HR related issues including recruitment and compensation packages of staff.  If some un-remunerative or loss-making sectors including agriculture or social sectors have to be financed by banks for policy reasons, they should be identified by GOI and entrusted to banks for financing on mutually agreed terms, which will include compensation for losses. Here the criterion should be specialization in work and not a differentiation between public and private sector banks.

 Major portion of the so called "stressed assets of banks" are in the private sector, and all of us continue to blame the banking regulator and the Public Sector Banks which are abused as conduits for mobilization of deposits from the public and transferring the public resources to private hands by design. If citizens decided to keep their hard earned savings only with the trustworthy, reliable private sector banks(In sum this is the impression analysts are trying to build up in the minds of depositors!) only, how public sector banks will misuse public funds? Taking this debate forward will be in public interest.

Reserve Bank of India has initiated informed debate on these issues during 2013-16 when Dr Raghuram Rajan was Governor and we are fortunate to have institutional continuity in policy perceptions at Mint Road through Dr Rajan’s successor Dr Urjit Patel and the toung Deputy Governor Dr Viral Acharya who succeeded Dr Patel. Viral Acharya in a recent (April 28, 2017) speech made the following observations:

“We keep hearing clarion calls for more and more government  funding for recapitalization of our public sector banks. Clearly, more  recapitalization with government funds is essential. However, as a majority shareholder of public sector banks, the government runs the risk of ending up  paying for it all. The expectation of government dole outs might have been set by the past practice of throwing more money after the bad. Take for instance our bank recapitalization plan of 2008-09 after the global financial crisis: banks that experienced the worst outcomes received the most capital in a relative sense. Most of these banks need capital again.”

It was in this background that Dr Acharya in his maiden speech after taking over as RBI Deputy Governor mentioned about various options to handle stressed assets. In his speech delivered at the Indian Banks’ Association Banking Technology Conference, on February 21, 2017, Dr Acharya observed:

“Let me mention the key  principles to successful restructuring that I have managed to glean:

First, there has to be an incentive provided to banks to get on with it and restructure the stressed assets at a price that clears the market for these assets. If they don’t do it in a timely manner, then the alternative should be costlier in terms of the price they receive.

Second, the ultimate focus of restructuring and of assessment as to whether the restructuring package being offered tothe bank is at the “right” price must be the efficiency and viability of the restructured asset.Generating the best price for the bank at all costs may only result in cosmetic changes and risk serial non-performanceof the assets.

Third, not all of the resulting bank losses should simply be footed by the government. As a majority shareholder of public sector banks, the government runs the risk of ending up paying for it all.

It should manage the process at the outset to avoid that outcome.

Wherever possible, private shareholders of banks should also be asked to chip in. Some surgical restructuring should be undertaken to consolidate and strengthen bank balance-sheets so that private capital will come in at better valuations. It might have to accept that it is best to let some banks shrink over time. Divestments should also be on the table.

Historically, significant restructuring of stressed assets has almost always involved significant bank restructuring.”

Stakeholders

Till recently, the three biggest stakeholders of banks, namely, the bank employees, the savers (depositors) and bank borrowers have remained mere spectators when various policy decisions were thrust on banks by government which, in one way or the other affected their interests. During the last two years, some awakening, which is a positive signal is visible.

Bank employees are daring to tell publicly that government cannot enforce adverse policy prescriptions on banks and when something goes wrong blame bank employees who implemented the policy.

Savers are openly talking about positive returns (net of inflation) for their bank deposits and safety of their hard earned savings in the context of rising NPAs in banks.

Those who borrow from banks have started analyzing cost-benefit aspects as they feel, the enforcement of credit discipline up to recovery could be more efficient now.

Expression of solidarity

I would like to view the Ordinance amending B R Act as an expression of solidarity by Government of India for the initiatives taken by the Reserve Bank of India to restore the health of the Indian Financial System during the recent years. Vested interests have been relentlessly continuing their efforts to weaken the regulatory and supervisory apparatus in the financial sector. Fortunately, GOI has, of late, started showing signs of having understood the role of an efficient, strong and professional central bank in maintaining financial stability for economic growth.

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*Submitted version of article published in The Global ANALYST, June, 2017