PSBs, Readying to meet new challenges : The Global ANALYST, June 2018


The Global ANALYST, June 2018

Public Sector Banks:
Readying to meet new challenges
M G Warrier
The 1980s and early 1990s were a period of great stress and turmoil for banks and financial institutions all over the globe, viz. Brazil, Chile, Indonesia, Mexico, several Nordic countries, Venezuela and USA, etc. In USA, more than 1600 commercial and savings banks insured by the Federal Deposit Insurance Corporation (FDIC) were either closed or given FDIC financial assistance during this period. More than 900 Savings and Loan Associations were closed or merged with assistance from Federal Savings and Loan Insurance Corporation (FSLIC) during 1983 to 1990. The cumulative losses incurred by the failed institutions exceeded US $ 100 billion. These losses resulted in the insolvency and closure of FSLIC and its replacement by the Resolution Trust Corporation (RTC) and the Savings Association Insurance Fund (SAIF)…”
Quoted above are the opening sentences from a discussion paper on “Prompt Corrective Action” circulated by the Reserve Bank of India (RBI) circa 2000. So much has been done by the central bank since then, to keep the banking system in India live and healthy. If some public sector banks are today facing strong criticism from the clientele and the public ( taxpayers whose money is being ‘diverted’ to restore banks’ health) in equal measure, half the blame should be shared by their owners, GOI, operated by the political leadership which abuses the banking system for various reasons.
In his 2010 book “Fault Lines” Dr Raghuram Rajan wrote as under:
“In dire crises, some systemically important firms may eat through their capital and be close to failure no matter how good the prior supervision or how ample the equity buffers. If some of their activities are essential to overall economic health, we need to figure out how to “resolve” them- to keep the core business running while imposing appropriate costs on investors. One of the key objectives of the resolution mechanism is to impose appropriate losses on debt holders so that debt holders do not merrily acquiesce equity holders’ tail risk-taking without demanding an additional risk premium, confident they will be bailed out by the government if necessary.”
The policy stance taken by RBI during Dr Rajan’s regime (2013-16) on handling stressed assets of the banking system in India needs to be attributed to the clear understanding of the mechanics of resolution processes, put in black and white by Dr Rajan three years earlier to his becoming RBI governor.

 N. S. Vishwanathan, Deputy Governor, Reserve Bank of India, in his speech at National Institute of Bank Management, Pune on Fourteenth Convocation on April 18, 2018 (see Appendix for excerpts) made the following observations about banks’ approach in general to handling stressed assets:
“The general approach of bankers to stress in large assets has been one of avoiding the de jure recognition of non-performance of such accounts. This is why we have a history of a large number of cases of failed restructuring as the schemes were used for avoiding a downgrade rather than resolving the asset. Prolonging the true asset quality recognition suited both the bankers and the borrowers. The former could make their books look cleaner than they actually were; the latter could avoid the defaulter tag even while, in fact defaulting. Governor had referred to this in his March 14, 2018 speech (https://www.rbi.org.in/home.aspx) as the borrower-banker nexus, which may not have a pejorative connotation, but implied that the banks indulged in the proverbial act of extending and pretending. It is instructive to mention here that most cases where the SDR scheme was invoked did not result in a change of management, implying that the scheme was used only for the asset classification benefit during the standstill period of 18 months. The strike rate in case of S4A was somewhat better because there were preconditions to the applicability of the scheme and the Overseeing Committee (OC) ensured strict adherence to the framework upfront. However, the total value of such cases in the overall scheme of things was not that significant.”
The above two quotes, hopefully, serve the purpose of clearing the misinformation being spread in the media that the present problems faced by PSBs are new developments previously unknown to the regulator. What has really happened is use of new diagnostic tools for assessing the health of the banking system and insisting enforcement of necessary discipline in sanction of credit and recovery of dues by banks have brought to surface several unhealthy practices indulged by banks to support powerful borrowers in looting depositors’ money. Both public sector and private sector banks have been indulging in unhealthy lending practices.  Private Sector Banks, as they could be more selective in the choice of clientele and were able to hire better professionals, are able to camouflage things and bring out glossy pictures while publishing their accounts and balance sheets. The expectation of all banks has been that their losses will be made good periodically by the government, using taxpayers’ money.
Banks under Prompt Corrective Action
The Non-Performing Assets (NPAs) of Public Sector Banks (PSBs) have gone up substantially in recent times, forcing RBI to put them under Prompt Corrective Action (PCA). Currently, half the total number of PSBs is under PCA framework, which includes Dena Bank, Allahabad Bank, United Bank of India, Corporation Bank, IDBI Bank, UCO Bank, Bank of India, Central Bank of India, Indian Overseas Bank, Oriental Bank of Commerce and Bank of Maharashtra.
 Owner responds
Finance Minister Piyush Goyal in a recent interaction with the senior executives of the 11 public sector banks placed under the Prompt Corrective Action (PCA) framework of the Reserve Bank of India (to check the deteriorating financial health of these banks) told that GOI will extend help to strengthen these banks to come out of PCA framework as quickly as possible. Goyal added that the government will prepare an action agenda on a case-by-case basis, with help of Department of Financial Services, to resolve the issues. The minister said that his meeting with the bankers was very useful to understand what had transpired over the last 12-13 years in the banking system and the heads of the 11 banks shared some very good ideas in the meeting to resolve the crisis.
Eye opener
The recent cash crunch which resulted in ATMs in several areas in India going dry prompted SBI’s Economic Research Department probe into the reasons for the shortage of cash when the currency in circulation did not go down drastically. The findings of the study include:
·       Rs2000 notes were not being circulated enough, especially in states like Bihar and Gujarat and in the southern states;
·       ATM withdrawals in the second half of 2017-18 were unusually high;
·       Currency velocity (the rate at which currency should be circulating in the market) was on decline resulting in lesser ‘cash in hand’ with banks;
·       The Research Team was not convinced about the reasons like marriage season, harvest etc. for cash crunch as those are not particular to 2017-18.
CFA statement
Smelling a conspiracy to destroy Public Sector Banks (The Global ANALYST has repeatedly talked about the step-motherly treatment meted out to PSBs, falling short of calling it a conspiracy!), the Centre for Financial Accountability (CFA), an independent platform has submitted to Finance Secretary (GOI) and RBI on April 28, 2018 a public statement accusing the government of hatching a well-orchestrated game plan to destroy public sector banks. According to reports, the statement has been signed by 95 eminent individuals belonging to civil society, bank associations and civil rights associations.
Lack of professionalism in formulation and implementation of some of the recent RBI/GOI initiatives to reform the banking system has invited scathing criticism from the signatories of the above statement. They include demonetization and post-demonetization currency management, Financial Resolution and Deposit Insurance (FRDI) Bill, ATM cash crunch (an aftermath of outsourcing operations of ATMs) and ad-hocism in levying service charges by banks. Attributing motives and calling it ‘a multi-pronged attack on the people, the public sector banks and the economy at large’, the statement asserts that “This cannot be brushed aside as an outcome of mismanagement or wrong policies of the government, regulators and bank management. It appears to be a part of a well-orchestrated and deliberate effort to cause mistrust in public sector banks, dismantle their networks and pave the way for privatizing the public banks”.
Minus the terse ‘trade union’ language, the statement conveys a clear message for managers and regulators of public sector banks. ‘First Aid’ solutions like infusing capital or sending out ‘guidelines’ will not take them out of the present mess which is not their creation.
Road ahead
Public Sector Banks need to be recognized as ‘independent professional service organizations’ on par with their counterparts elsewhere including those in the private sector in India. The Government of India should not exercise ‘ownership rights’ over them to break or bend rules in favor of business houses or for that matter, social sectors. Any loss incurred by them solely emanating from the implementation of government policy should be made good out of budgetary provisions in a transparent manner. Last but not least, their top management positions including those at board level should be filled with competent candidates and should not be seen as resting places for retired/retiring civil servants or avenues to compensate failures elsewhere.
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(The writer is a Mumbai-based consultant and author of "India's Decade of Reforms: Reserve Bank of India at Central Stage"(Notion Press, Chennai 2018))
Appendix
Excerpts from RBI Deputy Governor N S Vishwanathan’s address at National Institute of Bank Management, Pune on Fourteenth Convocation, April 18, 2018
The general approach of bankers to stress in large assets has been one of avoiding the de jure recognition of non-performance of such accounts. This is why we have a history of a large number of cases of failed restructuring as the schemes were used for avoiding a downgrade rather than resolving the asset. Prolonging the true asset quality recognition suited both the bankers and the borrowers. The former could make their books look cleaner than they actually were; the latter could avoid the defaulter tag even while, in fact defaulting. Governor had referred to this in his March 14, 2018 speech (https://www.rbi.org.in/home.aspx) as the borrower-banker nexus, which may not have a pejorative connotation, but implied that the banks indulged in the proverbial act of extending and pretending. It is instructive to mention here that most cases where the SDR scheme was invoked did not result in change of management, implying that the scheme was used only for the asset classification benefit during the standstill period of 18 months. The strike rate in case of S4A was somewhat better, because there were preconditions to the applicability of the scheme and the Overseeing Committee (OC) ensured strict adherence to the framework upfront. However, the total value of such cases in the overall scheme of things was not that significant.

The amendments to the Banking Regulation Act, 1949 empowering the Reserve Bank to direct banks to refer specific cases of default for resolution under IBC were a clear indication that an external nudge was required for banks to file insolvency application against large borrowers. As you may be aware, RBI constituted an Internal Advisory Committee (IAC) in 2017 to determine cases to be referred under IBC. Based on its recommendations, a total of 41 accounts were identified for such reference in two tranches. The IAC opined that RBI should evolve a steady-state framework for filing insolvency applications in future, rather than identify cases itself periodically.
The New Paradigm
The recommendation of the IAC made eminent sense for the following reasons. Firstly, the IBC is a comprehensive and time-bound framework for dealing with corporate stress. Secondly, a clear articulation of policy in this regard will bring certainty to all the stakeholders. Thirdly, a steady-state framework for reference under IBC was the logical outcome of the amendments to the BR Act; it would not have been equitable, if the powers were used for a limited time for a limited number of cases. Finally and more importantly, the IAC recommendation was in consonance with Reserve Bank’s preference all along for an efficient legal framework for insolvency and bankruptcy over regulatorily mandated schemes.
It was therefore, decided to go ahead with the recommendation of the IAC. Since a process-oriented Code was enacted in the country which also provided for exploring resolution options before liquidation, another process-oriented regulatory framework for out-of-court resolution of stressed assets was considered redundant. The Reserve Bank decided that rather than having two process-oriented frameworks, it would be beneficial to have two complementary frameworks that seamlessly align with each other - one which provides full flexibility for out-of-court workouts to be explored within a reasonable period after default, failing which, the other, viz., the statutory process under the IBC would kick in.
The new framework for resolution of stressed assets outlined in the Reserve Bank’s circular of February 12, 2018 is an outcome of the above philosophy. You would notice that unlike the earlier frameworks, this is more outcome-oriented and leaves considerable flexibility to banks to determine the process as well as the contours of the restructuring plan. The revised framework removes various process and input constraints which were embedded in the earlier regulatory schemes for restructuring. Instead it provides as much flexibility as possible to lenders and the stressed borrowers so long as a credible resolution plan is implemented within a specified timeframe. If lenders and the stressed borrowers are unable to put in place a credible resolution plan within the timelines, then the structured insolvency resolution process under the IBC should take over.
Let me highlight some other noteworthy features. The revised framework tries to reduce the arbitrage the borrowers are currently enjoying while raising funds through borrowing from banks vis-à-vis raising funds from the capital markets. If a borrower delays coupon/principal payment on a corporate bond even for one day, the market would penalize the borrower heavily – the rating would be downgraded, the yields on the bonds would shoot up, cost of further financing would increase, suits would be filed by investors, etc., to name a few. So far, defaults in bank borrowings have not attracted similar reactions. Only when the overdues stretch beyond 90 days, the loans would be classified as non-performing assets; hence, efforts by lenders and borrowers have been to avoid the account having to be de jure classified as NPA, notwithstanding the de facto status. What this means is that debt contract embedded in bank loans in India has been continuously losing its sanctity, especially where the borrowing is large. There is a need to change this and restore the sanctity of the debt contract, lest bank debt becomes subordinate even to equity. The new framework is precisely aimed at doing this. Prompt repayment to banks is critical because they access unlimited uncollateralized funding from among others, the common persons, on the strength of the banking licence.
What the revised framework also does is to enjoin upon the banks as creditors to enforce their contracts or renegotiate their contracts with their borrowers so that they are not in default in the first place. Where the contracts are renegotiated, banks books should reflect this through asset classification and provisioning. This is why the framework requires banks to report even one day default and draw up resolution plans thereupon such that the borrower is not in default as on 180th day from the date of such default. You would have noted that while it is mandatory to report defaults on a weekly basis, the classification of loans as non-performing assets will still be on the 90-day-past-due criterion. As such, the idea is to nudge lenders and borrowers to take timely corrective action so that the deterioration in the asset quality is avoided to the extent possible. At the same time, with defaults being reported to a central database, which is accessible to all banks, the credit discipline is expected to further improve.
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Source : RBI Website


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