What Do PSBs Want? :: Just Keep the Bad Borrowers at Bay!

What Do PSBs Want?*
No ‘Bad Bank’ Please! Just Keep Bad Borrowers at Bay!
M G Warrier

We have, on different occasions covered the “Bad Bank” story in some detail in different contexts. On July 2, 2018, the Hindu Business Line published a full-page feature captioned “‘Can ARCs ease banks’ burden?”. Bureaucracy has its own ways of getting things done in its way and this is the latest example of such efforts. The report is indicative of how vested interests keep certain ideas floating until they could be pushed through. To recap:
The idea of ‘Bad Bank’ was mooted in Economic Survey 2016-17, then called ‘Public Assets Rehabilitation Agency’ (PARA). All the reasons for not going ahead with institutionalizing bad assets remain valid today except that the idea now gets support from badly managed banks facing the threat of merger which expect to get another lease of life by transferring a portion of stressed assets to the new entity.
In India, fortunately, big public sector banks which have the major portion of NPAs are big enough to professionally manage their own affairs, if functional parity in management and conduct of business is allowed which their counterparts in the private sector enjoy.
The reality that the concept of an independent institutional arrangement for handling stressed assets of the banking system has built-in features that will be harmful for the financial sector in the long run. The possibility of such a depository of impaired assets acting as a disincentive for professionalizing credit appraisal, credit delivery/monitoring and recovery systems, which process is on track now, seems to have been taken cognizance of, by the Sunil Mehta Panel which has dropped the idea of ‘Bad Bank’.
Outsourcing of responsibilities at certain layers of credit appraisal or super-imposing decisions using ownership rights through back door have already contributed to the present NPA situation in PSBs. Shifting the responsibility for recovery from the lender to another agency goes against the principles of best banking practices. Creating a separate ‘pocket’ for decaying assets can further weaken the supervisory and regulatory bodies in the financial sector for obvious reasons and the idea should be given a decent burial at this stage.
But, as the growing NPA menace continues to challenge the future of Indian Banking System, GOI and RBI together are making all efforts to contain the damage. One gets an impression that this time around, all stakeholders have woken up from the slumber induced by the reassurances from the owner of PSBs (GOI) that depositors’ interests are safe in banks. Having said that, utmost care is needed to ensure that the possible scare in the public mind emanating from the analyses of data on banks’ stressed assets (NPAs), magnified by the ‘flashes’ about scams, do not get blown up out of proportion. Such a situation can adversely affect the already impaired health of the Indian financial system.
Here, a couple of observations made by former RBI Governor Dr Y V Reddy in a recent speech in Kolhapur are relevant. I quote:
“…The Non-Performing Assets in 1996-97 were 17.8 percent of gross advances and 9.2 percent of Net Advances. These ratios are much higher than what is prevailing today at 11.7 percent and 6.9 percent in 2016-17.  They were brought down to 9.4 percent and 4.5 percent in 2002-03, still higher than in 2015-16…. There were weak banks, and some public sector banks needed a capital injection.  These issues were addressed quietly, gradually and systematically.  As a result, the NPAs were down to 2.0 percent and 0.9 percent in 2008-09…”
“…Bank deposits continue to be as safe as they have ever been, as far as private sector banks are concerned.  They have adequate capital.
 The public sector banks do not have adequate capital to take care of the depositors' interest, but since the majority ownership is that of the government, the deposits are safe.  These are not limited liability companies, but institutions established under the law.  However, the depositors are protected with the tax-payers money. …”
As the health of PSBs remained neglected and these institutions were exploited for different purposes by different interest groups, the recent efforts by RBI to use modern diagnostic tools and ‘surgical treatment’ have brought several uncomfortable realities to the fore. These should be seen as positive signs leading to the infusion of professionalism in the conduct of banking business in India.
The introductory to the “Statement on Developmental and Regulatory Policies” released by Reserve Bank of India simultaneously with the Bimonthly Monetary Policy Statement issued on June 6, 2018 read as under:
“This Statement sets out various developmental and regulatory policy measures for strengthening regulation and supervision; broadening and deepening financial markets; improving currency and debt management; fostering innovation in payment and settlement system; and, facilitating data management.”
As the mainstream media did not take much cognizance of this document published by RBI at www.rbi.org.in (see Box for excerpts) let us try a brief recap as the content helps understand why RBI is doing what RBI is doing. The statement covered (a) Increase in Liquidity Coverage Ratio (LCR) carve-out from Statutory Liquidity Ratio (SLR), (b) Changes in procedure/modalities in valuation of State Government Securities and spreading of MTM losses (c) Policy change providing for  Voluntary Transition of Urban Cooperative Banks into Small Finance Banks, (d) need to encourage formalization of the MSME Sector, (e) Convergence of Priority Sector Lending (PSL) guidelines for housing loans with Affordable Housing definition under Pradhan Mantri Awas Yojana and (f) Decision to permit Core Investment Companies to invest in Infrastructure Investment Trusts (InvITs) as Sponsors  under Regulation and Supervision.
Excerpts from Statement on Developmental and Regulatory Policies*
This Statement sets out various developmental and regulatory policy measures for strengthening regulation and supervision; broadening and deepening financial markets; improving currency and debt management; fostering innovation in payment and settlement system; and, facilitating data management.
I. Regulation and Supervision
1. Increase in Liquidity Coverage Ratio (LCR) carve-out from Statutory Liquidity Ratio (SLR)
As per the existing roadmap, scheduled commercial banks have to reach the minimum Liquidity Coverage Ratio (LCR) of 100 per cent by January 1, 2019. Presently, the assets allowed as Level 1 High Quality Liquid Assets (HQLAs) for the purpose of computing LCR of banks include, inter alia, Government securities in excess of the minimum SLR requirement and, within the mandatory SLR requirement, Government securities to the extent allowed by the Reserve Bank under Marginal Standing Facility (MSF) [presently 2 per cent of the bank's NDTL] and under Facility to Avail Liquidity for Liquidity Coverage Ratio (FALLCR) [presently 9 per cent of the bank's NDTL]. For the purpose of computing LCR, it has been decided that, in addition to the above-mentioned assets, banks will be permitted to reckon as Level 1 HQLAs Government securities held by them upto another 2 per cent of their NDTL under FALLCR within the mandatory SLR requirement. Hence, the total carve-out from SLR available to banks would be 13 per cent of their NDTL. The other prescriptions in respect of LCR remain unchanged.
2. Valuation of State Government Securities
As per extant guidelines on prudential norms for classification, valuation and operation of investment portfolio by banks, the state government securities are valued applying the Yield to Maturity (YTM) method with a uniform mark-up of 25 basis points above the yield of the Central Government securities (G-Secs) of equivalent maturity.
It has now been decided that the securities issued by each state government should be valued based on observed prices. The valuation of traded state government securities shall be at the price at which they have been traded in the market. In case of non-traded state government securities, the valuation shall be based on the state-specific weighted average spread over the yield of the central government securities of equivalent maturity, as observed at primary auctions. The detailed guidelines to this effect will be issued separately by June 20, 2018.
3. Spreading of MTM losses
In the wake of spurt in the yields of government securities, banks were given an option to spread, over four quarters, the mark-to-market losses recorded on their investment portfolio during the quarters ended December 2017 and March 2018. It was also required that banks build an Investment Fluctuation Reserve (IFR) of 2 percent of their holdings in the AFS and HFT categories to avoid such eventualities. In view of the continuing rise in yield of government securities as also the inadequacy of time to build IFR for many banks, it has been decided to grant banks the option to spread the mark-to-market (MTM) losses on investments held in Available for Sale (AFS) and Held for Trading (HFT) portfolio for the quarter ending June 30, 2018, equally over a period of four quarters, commencing from the quarter ending June 30, 2018. The circular in this regard will be issued within a week.
4. Voluntary Transition of Urban Cooperative Banks into Small Finance Banks
The High Powered Committee on Urban Cooperative Banks (UCB), chaired by Shri R. Gandhi, the then Deputy Governor of Reserve Bank, had, inter alia, recommended the voluntary conversion of large Multi-State UCBs into Joint Stock Companies and other UCBs which meet certain criteria into Small Finance Banks (SFBs). Taking these recommendations into consideration, it has been decided to allow voluntary transition of UCBs meeting the prescribed criteria into SFBs. The detailed scheme will be announced separately.
5. Encouraging formalization of the MSME Sector
In February 2018, banks and NBFCs were allowed to temporarily classify their exposures to the Goods and Services Tax (GST) registered Micro, Small and Medium Enterprises (MSMEs), having aggregate credit facilities from these lenders up to 250 million, as per a 180 day past due criterion, subject to certain conditions. This was done with a view to ease the transition of MSMEs to the formalized sector post their registration under the GST.
Having regard to the input credit linkages and associated issues, it has now been decided to temporarily allow banks and NBFCs to classify their exposure, as per the 180 day past due criterion, to all MSMEs with aggregate credit facilities up to the above limit, including those not registered under GST. Accordingly, eligible MSME accounts, which were standard as on August 31, 2017, shall continue to be classified as standard by banks and NBFCs if the payments due as on September 1, 2017 and falling due thereafter up to December 31, 2018 were/are paid not later than 180 days from their original due date.
In view of the benefits from increasing formalization of the economy for financial stability, the 180 day past due criterion, in respect of dues payable by GST registered MSMEs from January 1, 2019 onwards, shall be aligned to the extant norm of 90 day past due in a phased manner, whereas for entities that do not get registered under GST by December 31, 2018, the asset classification in respect of dues payable from January 1, 2019 onwards shall immediately revert to the 90 day norm.
Detailed guidelines are being issued separately.
6. Convergence of Priority Sector Lending (PSL) guidelines for housing loans with Affordable Housing definition under Pradhan Mantri Awas Yojana
In order to bring greater convergence of the Priority Sector Lending guidelines for housing loans with the Affordable Housing Scheme, and to give a fillip to the low-cost housing for the Economically Weaker Sections and Lower Income Groups, it has been decided to revise the housing loan limits for PSL eligibility from existing 28 lakh to 35 lakh in metropolitan centres (with population of ten lakh and above), and from existing 20 lakh to 25 lakh in other centres, provided the overall cost of the dwelling unit in the metropolitan centre and at other centres does not exceed 45 lakh and 30 lakh, respectively. A circular in this regard shall be issued by June 30, 2018.
7. Emerging Developments in Low Ticket Housing
After a careful analysis of the Housing Loans data, it has been observed that the level of NPAs for the ticket size of up to Rupees two lakh has been high and is rising briskly. Banks need to strengthen their screening and follow up in respect of lending to this segment in particular. The Reserve Bank is closely monitoring this sector and will consider appropriate policy response such as a tightening of the LTV ratios and/or an increase in the risk weights, should the need arise.
*Source: RBI Website

Mehta Panel on NPAs
Last month, through a timely and thoughtful intervention in June 2018, GOI appointed a committee under PNB non-executive chairman Sunil Mehta with the SBI chairman and Bank of Baroda managing director PS Jayakumar as members to study and make recommendations for the resolution of the NPA issue. The Mehta Panel report was accepted by GOI during the first week of July 2018. In a media interaction Union Minister Piyush Goyal, announcing the acceptance of the recommendations explained the future course of action as under:
Independent asset management companies (AMCs) and steering committees will be set up for faster resolution of bad loans in the banking system. The proposal is to set up an asset management company/alternative investment fund (AIF)-led resolution approach to deal with NPA cases of more than Rs 5 billion. There are about 200 accounts, each of which owes more than Rs 5 billion to banks. Their total exposure is about Rs 3.1 trillion. AIF would raise funds from institutional investors. According to the minister, the AMC, to be set up under AIF framework, will become a market maker and thereby ensure healthy competition, fair price and cash recovery.
The committee has also suggested an asset trading platform for both performing and non-performing assets.
The panel has also suggested a plan for dealing with bad loans up to Rs 500 million. Under the SME Resolution Approach (SRA), loans up to Rs 500 million would be dealt using a template approach supported by a steering committee. The panel has recommended that the resolution should be non-discretionary and completed in a time bound manner within 90 days.
The Mehta committee has proposed a Bank Led Resolution Approach (BLRA) for loans between Rs 500 million and Rs 5 billion. This segment has an exposure of over Rs 3 trillion. Under the BLRA approach, financial institutions will enter into an inter-creditor agreement to authorize the lead bank to implement a resolution plan in 180 days. The lead bank would then prepare a resolution plan including empanelling turnaround specialists, and other industry experts for the operational turnaround of the asset. In case the lead bank is unable to complete the resolution process within 180 days, the asset would go to NCLT.
The gross non-performing assets (NPAs) of PSBs stood at Rs 7.77 trillion at end-December 2017. Total NPAs of all banks, including private ones, was a whopping Rs 8.99 trillion.
A word about resources mobilization
After releasing the Mehta Panel report on NPAs, Sunil Mehta mentioned in a media interaction that Rs800-900bn would be needed to resolve large toxic loans. The immediate media response to the Mehta Panel report on NPAs resolution is comforting.
Last three years have been stressful for banks, government and the banking regulator. Not only because the efforts to cleanse the financial system from various chronic ills resulted in several weaknesses of the system surfacing or the rising demands on budgetary allocations to support ailing banks. The period also brought to light deficiencies and vulnerabilities in management of institutions across public and private sectors. During this period the institutional system in the Indian Financial Sector has proved its resilience to withstand pressure and has retained public trust.
Banking being solely dependent on monetary resources, emphasis on ensuring capital adequacy, a reasonable growth in deposits base and flow of credit is natural. Sunil Mehta has arrived at a tentative figure of Rs800-900bn to resolve large toxic loans. There will be other demands, besides the likelihood of this figure too rising higher.
Extraordinary situations call for extraordinary solutions. Taking a clue from Mehta’s observation that “…the returns on stressed assets are quite different from biotechnology, IT and private equity funds,” GOI should consider tapping ‘idle domestic assets’ for long-term investment in the banking sector.
Several individuals and organizations may be holding assets in cash, gold and real estate, a part of which, if allowed to be mainstreamed and invested may partly cover the huge funding need at this juncture. Of course, creating national consensus and building public trust will be an uphill task.

*Submitted version of the article published in the August 2018 issue of The Global ANALYST 


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