India must prepare to tackle the NPAs issue by following up Asset Quality Review with pragmatic appraisal and effective implementation of possible new solutions. RBI carrying out deep surgery with AQR-led clean-up of banks’ balance-sheets is bold and praiseworthy. However, with the country’s stressed assets at 12.3% of total outstanding loans—the highest among major emerging markets—decisive solutions to resurrect the banking sector are needed. The surge in NPAs has taken an immense toll on credit growth, now at a multi-decades low. With concentration of NPAs in industry, banks (particularly public sector ones) are grappling with deteriorating capital base, and have materially squeezed lending portfolios.
The rise of NPAs and a continuous decline in non-food bank credit over the past few years is a worrying trend. Several studies establish a strong correlation between growth and bank credit. As per CARE Ratings, between 1953 and 2014 , the degree of correlation was 0.30. It increased consistently to 0.49 for the last 30 years, and to 0.65 for the last 10 years. RBI Deputy Governor S S Mundra, in a speech in September 2016, pointed out that bank credit growth between 2000 and 2014 averaged 1.6 times the GDP growth. A basic extrapolation of this number leads us to a required credit growth of ~13% to achieve a GDP growth of 8%. In India’s banks-dominated financial sector, revival of corporate investments hinges largely on a robust uptick in credit growth. Banks’ failure to address NPAs has choked fresh loans to industry.
Adding to the woes of banks in effecting a turnaround in the NPAs cycle, numerous loan restructuring programmes and schemes like Corporate Debt Restructuring, Strategic Debt Restructuring, Sustainable Structuring of Stressed Assets, etc, did not yield desired results. Most of these schemes either had loopholes that gave companies escape routes or were ambiguous about certain crucial aspects. Banks cherry-picked certain aspects in order to hide the stress on their balance-sheets and further exacerbated the problem.
While the Insolvency and Bankruptcy Code should help unlock NPA resolution, potentially releasing an estimated Rs 25,000 crore worth of capital in five years, it alone will not be sufficient to tackle the mountain of NPAs. It could, at best, address NPAs in the future. Moreover, it can’t address the failings of PSBs, where the management is resistant to book a loss on stressed loans due to the fear of investigating agencies.
After years of exploring several possible solutions, RBI recognises that the progress of several resolution mechanisms and frameworks offered has not been successful. In a recent speech, RBI Deputy Governor Viral Acharya drilled down on the subject and pointed out plausible solutions—a Private Asset Management Company (PAMC) and a quasi-governmental National Asset Management Company (NAMC). These prospective solutions deserve careful examination and stakeholders’ consultation to realise their potential in addressing the NPA woes.
The PAMC route is suggested for sectors where stressed assets have economic value in the short-run with moderate level of debt forgiveness, such as metals, EPC, telecom and textiles. The framework proposes calling upon asset-specific, time-bound resolution plans from turnaround specialists and investors, laying out sustainable debt and debt-for-equity conversions for banks and providing for cash-flow prospects. After rating of assets under each plan by at least two credit-rating agencies, banks can choose feasible plans that improve rating of the asset with maximum efficiency. The model strikes a balance between restructuring-plan approval and an oversight mechanism, haircut provisions for banks and incentives for new managing investors that can help discover a fair clearing price for stressed assets.
The NAMC model, mirroring the Economic Survey’s Public Sector Asset Rehabilitation Agency, is for sectors that have excess capacity, and a lot of economically unviable assets in the short- to medium-term, e.g., power and infrastructure. NAMC will raise debt for its financing needs, possibly also pay off banks at a haircut, keep a minority equity stake for the government, and bring in asset managers such as ARCs and private equity to turn around the assets, individually or as a portfolio.
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A distinct feature of the proposed structures is the shift away from the ‘bad bank’ approach as both these models assume the form of asset management companies (AMCs) which would not be allowed to become banks. Learning from the experiences of advanced economies, these models ensure no mission creep over time. The models share many features with approaches taken by a number of developed as well as developing countries, including the US, Spain, South Korea, Indonesia and Malaysia. While such approaches have worked for many countries in the past, the demand for similar structures is gaining firm ground in Europe, to deal with the 1-trillion-euro toxic-loan pile. Officials at the European Banking Authority have proposed creating a publicly-funded, pan-European ‘bad bank’.
While global experiences offers important learning, the model India selects should have simple structures with an enabling policy and regulatory environment. With significant convergence emerging in the thinking of RBI and the finance ministry over dealing with NPAs, it is reasonable to expect that the proposed asset resolution agency structures could offer potent new solutions to de-stress the banking sector. After all, an effective stressed asset resolution framework is imperative for India to unlock productive capacities, spur job creation and realise its potential growth rate.
With inputs from Dipti Chawla and Gaurav Sharma.
Author is Leader (risk & advisory), BMR Advisors. Views are personal.