Bad loans: Banking ordinance is an imperfect solution to the stressed assets crisis

Published: May 9, 2017 7:28:03 AM

The government has issued an extraordinary gazette on May 5, notifying the ordinance to address the issue of stressed assets in the Indian banking system.

The second insertion is Section 35 AB in the Banking Regulation Act 1949. (Reuters)

The government has issued an extraordinary gazette on May 5, notifying the ordinance to address the issue of stressed assets in the Indian banking system. The preamble to the Ordinance recognises that (i) stressed assets have reached unacceptable levels; and (ii) the Insolvency and Bankruptcy Code (IBC) 2016 has already been enacted for insolvency resolution of entities in a time-bound manner, for maximisation of value of stressed assets to promoters, and availability of credit, and balancing the interest of all stakeholders.

Banks and promoters—borrowers, in particular—know this well. So far, so good. The problems start thereafter, when the preamble to the Ordinance concludes that empowering the banking regulator to issue directions to banks to invoke IBC 2016 on specific cases of stressed assets for their effective resolution can effectively address the NPA issue.

The Reserve Bank of India (RBI), the banking regulator, already has powers under Section 35A of the Banking Regulation Act 1949 to issue directions in public interest or in the interest of the banking system, to banks in general or a particular bank. However, this power is perhaps not sufficient to enable RBI to issue directions to banks or a bank in a particular case. Therefore, the Ordinance inserts two more Sections in the Banking Regulation Act 1949.

The newly inserted Section 35 AA gives power to the government of India to authorise RBI to issue directions to a bank or banks to initiate resolution process in respect of a default under the provisions of IBC 2016. It seems the government of India, in view of the urgency of dealing with NPAs, lost no time in issuing a notification on the same day the Ordinance was issued, authorising RBI in this regard.

The second insertion is Section 35 AB in the Banking Regulation Act 1949. Section 35 AB (1) enables RBI to issue directions to banks from time to time for resolution of stressed assets, and Section 35 AB (2) enables RBI to specify one or more authorities or committees and appoint or approve their members, to advise banks on resolution of stressed assets.

RBI also acted fast, issuing a notification on the same day, invoking the newly acquired power under Section 35 AB (1) of the Banking Regulation Act 1949. The RBI notification emphasises that the essence of any resolution process is the timeliness of its implementation, unconditional and unambiguous decision-making and adherence to the decision made, etc. To facilitate quick decision-making, the threshold value of exposure of creditors has been reduced from 70% to 60%, and number of creditors from 60% to 50% for a majority decision, which will be binding on all creditors. RBI has also warned the banks that non-adherence to its direction by a bank will attract monetary penalty.

The stressed asset resolution process in the Indian banking system has been going on for a reasonably long time without any solution in sight. RBI tried its hands with many schemes like 5/25 flexible structuring of new and existing loans, strategic debt restructuring (SDR) scheme, with or without change in management, scheme for sustainable structuring of stressed assets (S4A), etc. The government also enacted the IBC 2016. However, banks were not effectively using these schemes. There are several reasons—one is definitely the financial capacity of banks to write down the loans by taking haircuts. But, the more serious factor is the ‘fear factor’, particularly, of the public sector banks (PSBs), in taking such decisions. The environment is also not conducive for them. The recent arrest of the chairman of a PSB did not improve matters; decision-making deteriorated further. In this context, the government probably did not have any option other than issuing the ordinance.

Is it a good solution? Banks are supposed to assess credit needs of the borrowers, banks are supposed to monitor the loans given and recover the loans when due. There will be some credit losses and banks should have the profit-making ability to make provision for and/or write-off bad loans. This is basic banking function. If in the process, a bank goes bankrupt, so be it. How can one expect the bank regulator to direct a bank what action to take against a specific stress asset? How can a committee or authority set up by the banking regulator know what is best for a bank so as to advise it on the resolution of a stressed asset? It is heartening to note that the government and the society in general, and the banking system, in particular, have so much faith in the banking regulator, i.e., RBI, or that a committee set up by it will take the right call on bank-action in respect of a stressed asset. RBI, which was the whipping boy during the recent process of demonetisation and remonetisation of high-value currency notes, has suddenly acquired such a towering stature! How about future stressed asset crises? Will it not discourage PSBs from taking commercial decisions? Banks will give loans, but if these become stressed, it becomes the job of the regulator to resolve the problem. Isn’t it “heads I win, tails you lose”? And isn’t it a moral hazard issue for the banking regulator?

How about the obscene acts of corporates who have fraudulently siphoned off money from bank loans? Will they continue to plunder public wealth? Will the IBC 2016, and the infrastructure set up under it, deliver ‘poetic justice’ to them in a timely manner?

The ordinance is an imperfect solution to a perfect problem. The problem lies in the structure of the banking system in the country, where more than 70% of banking is with the PSBs. Not that all private banks have come out of this crisis with flying colours, but a few of them have done exceedingly well in these trying conditions. The solution lies in privatising the PSBs with all the attendant governance enhancement and incentive structures. To start with, the government can, at the very least, repeal the nationalisation Acts, and bring PSBs under the Companies Act. This will end the ‘dual control’ of PSBs by the government and RBI, and improve corporate governance of the PSBs.

B Mahapatra

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