What, however, is more significant is the working paper’s conclusion that the ‘delays in legal procedures for reporting, and various loopholes in the system have been considered some of the major reasons of frauds and NPAs’. The government did respond to frauds through a series of actions against some bank officials, Between January 2017 and April 2018, at least half a dozen senior public-sector bankers were booked under various cases of fraud and corruption. It had a negative impact on the morale of public-sector bankers and made other bankers even more reluctant to take decisions on lending. Frauds and corruption in banking may not be the root cause of growing NPAs, but certainly one of the factors that needed better and more mature handling, particularly in public-sector banks.
The stage, thus, was set for one of the biggest disruptions in India’s financial sector. The bank NPAs had risen to an unsustainable level that the collateral damage of such a crisis would be huge for the Indian economy. The government as also the RBI got down to the task of addressing the NPA problem. Just as the RBI was expected to play its role as a regulator, the government too had to step in as it was the majority shareholder in public-sector banks, which accounted for about 80 per cent of India’s banking system.
From June 2014 to February 2018, the RBI took a series of steps to attack the NPA problem. It changed the way the banks could do business and altered the behaviour pattern of borrowers.
The 5/25 Refinancing of Infrastructure Scheme
Under this facility, a larger window for the revival of stressed assets in the infrastructure sectors and eight core-industry sectors was offered. This allowed lenders to extend amortization periods to twenty-five years with interest rates adjusted every five years. Extended amortization allowed the projects to write off or recover the cost of their assets over a more reasonable and longer period of time. This was aimed at matching the funding period with the long gestation and productive life of the projects. Longer amortization helped improve the credit profile and liquidity position of borrowers. At the same time, the scheme allowed the banks to treat these loans as standard in their balance sheets, which in turn helped them reduce their provisioning costs. An adverse consequence of the scheme was that with amortization spread out over a longer period, it imposed higher interest costs on borrowers, who faced difficulty in repaying their loans. Banks were thus forced to give more loans to the same borrowers. Such evergreening actually aggravated the earlier problem.
Private Asset Reconstruction Companies or ARCs
Even though the formation of asset reconstruction companies was allowed under the Securitization and Reconstruction of Financial Assets and Enforcement of Security Interest Act, 2002 (better known as the Sarfaesi Act), not too many of them were set up and even fewer were operational. ARCs are set up with the object of buying the debts of banks at a mutually agreed upon value and recovering those debts. In the process, banks are freed up of their bad loans and ARCs can make money by buying off the debt at a value lower than the amount they get by recovering the loan. ARCs have professionals on their boards, who undertake the tasks of resolving sticky loans and relieve their burden on the banks.
However, as the ARCs were prepared to take over the stressed loans at a very low price, banks were unwilling to transfer their loans to these companies. In August 2014, the fee structure of the ARCs under the law was modified, obliging them to pay upfront in cash a higher share of the purchase price of the stressed loan. ARC-led resolution did not make any progress after the modification and only about 5 per cent of the total NPAs at book value were sold in 2014–15 and 2015–16, according to the Economic Survey for 2016–17.
Strategic Debt Restructuring (SDR)
In June 2015, the RBI introduced the SDR scheme, which allowed banks to convert the debt of companies to 51 per cent equity and sell them to the highest bidders. Two conditions had to be fulfilled before any bank could use this scheme. One, loans of only companies whose stressed assets had been restructured earlier but could not eventually fulfil the conditions attached to the restructuring would qualify for the scheme. Two, the sale of equity to the highest bidders would be subject to the authorization of existing shareholders of the companies. The scheme had stipulated a period of eighteen months by when these transactions would have to be completed and the loans after that could be classified as performing. The response to this scheme too was lukewarm and by the end of December 2016, only two sales under the scheme had materialized.
Asset Quality Review (AQR)
In October 2015, the RBI enforced a new set of norms under which banks were forced to recognize the bad loans that had earlier been either ignored or had enjoyed some sort of regulatory forbearance. The principle of AQR was that resolution of the problem of bad assets required a robust system of recognizing them. The RBI advised the banks that they must undertake a thorough review of the quality of their loans as per the norms in force and any deviation from those rules must be rectified by March 2016—a window of just five months. This was an ongoing scheme and banks have been regularly monitoring their assets under AQR since then.
Sustainable Structuring of Stressed Assets (S4A)
This was introduced in June 2016. Under this arrangement, an independent body hired by the banks would decide on how much of the stressed debt of a company could become sustainable. The portions of the debt not defined as sustainable would be converted into equity and preference shares. The difference between S4A and SDR was that while in the latter scheme ownership could change after the sale of equity, there was no provision for any change in the ownership of the company under the former.
Prompt Corrective Action (PCA)
On 12 February 2018, the RBI took a big step in its efforts at early recognition and resolution of stressed assets. Under the revised framework, lenders were required to identify incipient stress in loan accounts immediately on default by classifying stressed assets under three broad special mention account (SMA) categories: SMA-0, where principal or interest payment or any other amount is wholly or partly overdue for between one and thirty days; SMA-1 for accounts with overdue amounts for thirty-one to sixty days; and SMA-2 for accounts with overdue amounts for sixty-one to ninety days.
Once they were identified as a stressed asset, they would have to be mandatorily referred to the national company law tribunal for processing under the Insolvency and Bankruptcy Code. A bank could not make fresh lending once it was placed under PCA. Not surprisingly, the revised guidelines under PCA were seen as the most stringent. Industry protested and complained that in its zeal to insist on early recognition of bad assets, the RBI was destroying whatever chances of recovery there were for some sticky loans. Industry complained that RBI’s earlier PCA guidelines in May 2014 and April 2017 were not as stringent. Even sections within the government were not too happy with the strict enforcement of PCA. Nobody could have quarrelled with the intention of the RBI though.
The government’s statement in Parliament in 2018 explained that the PCA framework was aimed at helping the banking sector maintain sound financial health and take corrective steps in a time-bound manner if its loans had gone bad and unrecoverable. The government also assured Parliament that its objective was not to constrain the banks’ normal performance but to encourage them to avoid undertaking risky activities, focus on conserving capital and improve operational efficiency. Eleven public-sector banks were brought under the PCA framework; these were Dena Bank, Central Bank of India, Bank of Maharashtra, UCO Bank, IDBI Bank, Oriental Bank of Commerce, Indian Overseas Bank, Corporation Bank, Bank of India, Allahabad Bank and United Bank of India.
These eleven banks accounted for quite a significant portion of banking activities in the country. With over 30,000 branches spread across the country, these banks held public deposits worth close to Rs 25 lakh crore. Denying them the right to take up any fresh lending activities was one of the toughest measures against NPAs and hugely impacted their customer base and their banking activities. The disruption it caused to the economy can hard
ly be overestimated. Many of these banks over time came out of the PCA framework by recovering their sticky loans and maintaining prudence. But a big setback was when in 2019 the Supreme Court, on an appeal from a clutch of affected companies, struck down the PCA framework on the ground that it was not consistent with the law. Consequently, the RBI had to reissue the same PCA circular after amending certain provisions that were frowned upon by the apex court. The revised circular was far less stringent, but its overall approach remained unchanged.
A question that is still being debated is whether the banks were saddled with the non-performing loans as a result of a decision that was taken in the early days of economic reforms. By the turn of the century, the government and the RBI had decided that developmental financial institutions would be given the option of turning themselves into commercial banks. Most of India’s developmental financial institutions including the ICICI and IDBI had soon turned into commercial banks. This also heralded the demise of developmental financial institutions in this country. However, many experts are of the view that most of these universal banks did not have the requisite skills of evaluating the risks of project financing. In many cases, this led to an asset-liability mismatch for the universal banks. The euphoria of the high-growth phase in the first half of the Noughties led to indiscriminate financing of projects, which had not been subjected to thorough scrutiny. The banks’ loans began turning sticky after the global financial crisis of 2007–08. But few attempts were made to recognize the growing NPAs and take corrective steps. Thus, the demise of the developmental financial institutions, arguably, could have played an indirect role in the NPA crisis of India’s banking sector.
CHAPTER 21
RECOGNITION, RECAPITALIZATION, RESOLUTION AND REFORM
Even as the banking sector was trying to come to terms with the various schemes introduced by the RBI to force them to recognize bad loans before they became a bigger problem, the government on its own introduced a set of measures for ensuring early Recognition, Recapitalization of public-sector banks, Resolution of bad assets and Reforms of banks (the four Rs). The implementation of each of these Rs posed new challenges for the financial sector and saw different types of disruption in the economy.
With respect to the first R—recognition of bad loans—a lot of action had already been initiated by the RBI in spite of resistance from banks, promoters who borrowed money from the banks and even from the government. It all started with the introduction of the AQR process and it was soon supplemented by the PCA. In between, there were many other initiatives like the 5/25 Refinancing of Infrastructure Scheme, SDR, Asset Reconstruction Corporations and S4A, and many of them posed their own implementation challenges. But what really worked were two initiatives—AQR and PCA. And resistance was the most in respect of these two initiatives.
The government also appeared to be not too happy about the RBI’s strict approach to enforcing its PCA guidelines. There was increasing clamour from industry that a large number of banks were out of business as a result of those strict recognition norms and that this was stifling funds flow to them, needed for making productive investments, which in turn would help the economy achieve higher growth. The case of a clutch of power companies that were in deep financial distress and needed a bank bailout became a bone of contention. The government wanted the RBI to allow some of the public-sector banks to resume lending to the stressed power companies so that they could rescue themselves from a financially tight situation. But the RBI was in no mood to listen to such entreaties.1 The matter went to the Allahabad High Court, which opined that the RBI could not be expected to change its guidelines and the government had the powers under the RBI Act to issue if necessary a direction to the central bank for making exceptions to the power sector firms for lending purposes. The government did issue a letter to the RBI governor to seek consultations with him under Section 7 of the RBI Act. However, there was not much progress on those consultations, particularly with regard to the enforcement or relaxation in the PCA framework for banks. While the relations between the RBI and the government had become tense for some time, there was truce later on after both the government and the RBI recognized that they must not air their differences through public forums and instead talk to each other to resolve their differences. But the problems that the enforcement of the PCA norms threw up showed how difficult as also disruptive these challenges could be for the country’s framework for governing and regulating the financial sector.
Reform
The second R was about reforms in the financial sector. The government was quite proactive on this front. In just about six months after the Narendra Modi government was sworn in, a bankers’ retreat called Gyan Sangam was convened in Pune on 3 January 2015. Prime Minister Modi was present at the meeting himself along with his Finance Minister and the top officials in the finance ministry. All top bankers were present at the meeting. While Modi talked about how the government had no desire to interfere in the functioning of the public-sector banks, the meeting resulted in the adoption of a programme or a plan of action that was called Indra Dhanush.
The Indra Dhanush package had four broad components. The first of these was to set up the Banks Board Bureau, which would be entrusted with the task of overseeing the governance of public-sector banks and seeking to distance their running from the political leadership in the government.
The second component was about the infusion of fresh equity into the public-sector banks to improve their capital adequacy. This was linked to the NPA problem these banks were suffering from and more capital was to have helped them attain the desired capital adequacy norms and continue to remain in the lending business.
The third component envisaged induction of private-sector talent to head the PSU banks, and the fourth component of Indra Dhanush underlined the need to set up a new institutional mechanism to repair the balance sheets of the stressed banks.
Some progress had certainly been achieved in many of these areas outlined in Indra Dhanush. For instance, the Banks Board Bureau was soon established and it set the ball rolling for appointing a few private- sector managers to head PSU banks. But that exercise slowed a bit after a while and the experiment of inducting private-sector talent into the public-sector banks did not yield the kind of positive results that were anticipated. The distancing of the bank managements from the political masters in North Block or South Block was a critical imperative, but the government did not make any progress in this area. No clear structure, as recommended by many expert committees in the past, was put in place to distance the management from the political executive as far as running the banks was concerned.
Recapitalization
The Indra Dhanush goal of recapitalization also made significant headway. There was some delay, of course. The promise of an Indra Dhanush package was announced in January 2015. But it took more than two years and nine months for the government to finalize its bank recapitalization plan. On 24 October 2017, the government announced a recapitalization package of about Rs 2.11 lakh crore, after consultation with the RBI. The package had three components: Rs 18,000 crore of capital to be issued to the banks from the Budget, Rs 58,000 crore of capital to be raised by the banks from the market over the next two years and Rs 1.35 lakh crore of capital for the banks after the government issued ‘Recapitalization Bonds’ in two instalments—one in 2017–18 and another in 2018–19. The government fulfilled its promise of issuing recapitalization bonds and providing capital to public-sector banks from the Budget without any further delay.
On 24 January 2018, Finance Minister Arun Jaitley announced that an estimated Rs 88,000 crore of capital would be infused into public-sector banks so that they could improve their capital adequacy and resume commercial lending and, in the process, help revive the economy’s investment cycle. The minister also referred to a set of performance yardsticks based on which the proposed capital infusion would take place. The government was also encouraged by the fact that in the wake of its announcement of t
he Indra Dhanush package, a few public-sector banks had already raised about Rs 10,000 crore from the capital market. This took the total recapitalization effort during the year close to Rs 1 lakh crore.
Issuing the recapitalization bonds was a smart move from the fiscal management perspective. The bonds had a tenure of ten to fifteen years. However, when it came to allocating the recapitalization bonds, the list of the banks that benefitted from such capital infusion raised disturbing questions on whether any performance criteria were indeed used to provide such capital assistance. Weaker banks got more bonds than those which had shown better performance. The government could certainly justify this approach as it felt that weaker banks needed the capital more than those that were relatively better off. But the principle of merit-based capital infusion was honoured more in its breach. The eleven public-sector banks that were under the RBI’s PCA plan got as much as 57 per cent of the total recapitalization bonds on offer and the remaining amount—about Rs 34,550 crore—was offered to non-PCA banks like the SBI, Punjab National Bank, Bank of Baroda, Canara Bank, Union Bank of India, Syndicate Bank, Andhra Bank and Punjab & Sind Bank.
The Rise of Goliath Page 31
