The Narendra Modi government’s ordinance on bad loans is an acknowledgement, for the first time, that bad loan scenario is far more worrying than what the government and the Reserve Bank of India (RBI) portrayed it. So far, the ministers and bureaucrats and even the central bank have been repeatedly saying that the NPA situation was not alarming and was well manageable. But, the ordinance shows there is a realisation within the government and RBI that close to Rs 10 lakh crore (on a conservative estimate) stressed assets in the banking sector is no easy riddle to solve. It is indeed a crisis-like situation that warrants urgent attention.
It is also the admission that earlier plans to deal with the banking sector stressed assets --
corporate debt restructuring (SDR), strategic debt restructuring (SDR) and, the scheme for sustainable structuring of stressed asset (S4A) have largely failed to resolve the problem of sticky assets.
Arguably, the last major exercise to address the NPA problem was initiated by former RBI governor, Raghuram Rajan, who pushed for early identification and full disclosure of bad loans in a timebound manner (by March 2017). But, even this call hasn’t succeeded in digging out the dirt from the bank balance sheets since a significant chunk of problematic assets are still shown as standard on bank balance sheets in the technical purview of special mention accounts (SMA).
Hence, the ordinance that directly involves the RBI (to advise banks) and the government (to authorise the RBI), is sort of a final act in the fight against bad loans.
Will it do the trick?
It has a few positives. One, the new law, coupled with the bankruptcy code, will instill the fear among corporate borrowers that if they don’t pay back, they are risking losing the control of the management and stricter punitive actions given that the RBI and government now have a direct say in the matter. In the past, defaulting companies managed to stay safe for long or delay action by negotiating with banks on technical adjustments (paying the minimum amount just enough to stay good on their records). Now, there will be more pressure on the companies to pay back.
Two, the likely direct involvement of RBI and government in bigger corporate default cases will free bankers from the fear of being prosecuted while recasting a loan or while taking a large cut to recover at least a part of a loan that has gone fully bad. The oversight committee to be set up by the RBI under the new law will shield the bankers from investigations on every other large loan default. In effect, this will give a free hand to the banker to act on recovery.
But, there are certain concerns too.
First, there is likelihood that the ruling political leadership can target or excuse certain companies by directing the RBI and banks to take action. It can force management changes and even wind up firms. What is the assurance that political interests would not guide such actions? In a scenario where the RBI’s powers are in the process of being curtailed or overruled even on the matters of monetary policy and currency management, the ultimate power will lie with the central government to dictate actions.
Here, we have a case of conflict of interest. The problem is that corporates are the biggest donors for political parties and with the recent change in the Union budget, companies can donate any amount to any political party without disclosing the name of the party. One cannot rule out the possibility that some of the big donors for the political parties are the big loan defaulters too. The power in the hands of the government to target or not to target loan defaulters thus opens the room for more backdoor dealings. This is a charge the Narendra Modi government may have to face in the days ahead.
Even the RBI will have to face questions on conflict of interest being the body that lays out rules for banking business and enforce it. Remember, resolving the NPA account should concern the bank first than the regulator. If RBI forces the bank to take a decision, which the bank does not find viable, will the central bank compensate for the monetary loss?
Second, even if the new ordinance works to dig out the hidden dirt from bank balance sheets and push for winding up of companies which do not pay back, the fundamental question of whether banks will get their money back or not remains. Consider these two scenarios. A bank or group of banks can either take over the management of a company that is in no mood to pay back or simply write off the loan. In both cases, bank is not going to get their money back immediately. This is because the value of the underlying assets of the loan would have already eroded by the time the take over happens and there will be hardly anything left for the banks to recover. Also, banks are not in the business of running companies. They don’t have any expertise to do that.
The Kingfisher-Vijay Mallya case should be an eye-opener. What is at stake for banks is around Rs 9,000 crore but the combined value of the assets of Kingfisher Airlines that can be sold off wouldn’t be more than a few hundred crores. When money doesn’t return, it will drill a huge hole on the books of the banks. What do they do taking over an airline? In the case of state-run banks, which have more than 90 per cent of total bad loans, the responsibility will be with the government to fork out this money. What if it fails to do this?
Also, looking beyond the cases of willful default and financial frauds, there are several cases of corporate loan defaults that are purely linked to slowdown in economic activities. During the period of high economic growth, banks rushed to fund several large infrastructure projects without properly identifying the risks. When projects didn’t take off and companies’ cash flows were further squeezed on account of cost overruns, loan repayment took a hit.
This is one reason for the huge number of stalled projects in the economy. With this, banks stopped funding industries to avoid further shocks creating a vicious circle. Unless there is a significant recovery in the economy for a sustainable period of time, loan repayment in such cases will continue to suffer.
Where the ordinance can really work is to hunt willful defaulters in the system. If the banking system uses this law to launch a massive, timebound crackdown on wilful defaulters and recover the money, a large part of the current crisis in the banking sector can be solved. According to all India Bank employees association (AIBEA), for the year ending March 31, 2016, public sector banks earned operating profit of Rs 1.37 lakh crore, while total provisions for bad loans and contingencies were Rs 1.55 lakh crore. According to C H Venkatachalam, general secretary of AIBEA, to resolve the bad loan problem, the government must crackdown on top 100 wilful defaulters to recover their dues. In the absence of such an action, the bad loan ordinance wouldn’t help, he said.
The bottom line is this: The bad loans ordinance gives more teeth for the banking sector to fight bad loans and is a right step. The new law will put fear in the minds of promoters of stricter action if they don’t pay back money to banks. But, this could also give room for larger problems on micromanagement and thereby a conflict of interest in the banking sector by both the government and the RBI, which will not augur well for the system in the long term.
Published Date: May 08, 2017 11:13 am | Updated Date: May 08, 2017 11:13 am