Fall in loan recast in June doesn't mean 'achhe din' are here for banks. Here's why

The amount of loans from troubled Indian firms, which was referred to the corporate debt restructuring (CDR) mechanism in the June quarter for potential loan recasts, stood significantly lower at Rs 13,000 crore compared with Rs 22,000 crore reported in the March quarter.

Similarly, the gross non-performing loans (NPAs) of listed banks, in the two consecutive quarters ending March, stayed around the same level, at about Rs 2,42,000 crore, signalling that the pace of bad asset generation in India’s Rs 86 trillion banking system has come down.

Does this mean that the pain of stressed assets that has been a major concern to the policymakers is over?

Unlikely. We may be still at least two quarters away from a point when one could say that the worst is over.

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Here is why.

For one, a major reason for the decline in the restructured loans under CDR channel is the new set of regulations from the Reserve Bank of India (RBI) early this year relating to early recognition of bad assets.

As per this, banks have to classify stressed assets in to specific categories when they see early signs of distress.

Technically called special mention accounts (SMA), banks need to put them into different categories from 30 days to 90 days, depending upon the quality of assets and form a joint lenders forum (JLF) to handle cases, where borrower’s interest or principal payments are overdue by more than 60 days.

Beyond 90 days, the loan turns bad, leaving no scope for recast. Banks need to set aside money as provisions up to 100 percent value of the asset if the loan turns fully bad, or chances of recovery is perceived to be zero.

Now, the uncertainty among banks that has led to fewer number of CDR cases is this:

Once the JLF is formed, there are typically three ways a stressed asset can be dealt with.

1) Rectification of the asset, which means either the company could either pay back the money to the banks or the banks provide additional funds to the firm to resolve the stress, if the stress is temporary in nature.

2) The asset can be moved to CDR, where the company, if identified as a genuine case of stress, will be offered relaxed terms for paying back the loan amount that could typically come as a combination of reduction in lending rates, elongated repayment period and, in some cases, banks opting for a sacrifice.

3) Recovery through winding up the company and recovering the loan amount.

At present, there is a lack of understanding or agreement among banks on which one of the above three ways should be opted for to comply with the central bank’s rules in letter and spirit.

Second, there was a sentimental factor that was playing out in the June quarter after the Modi government assumed power. There are several companies that are in the queue to be taken up for CDR but have temporarily put the plan on hold hoping that things will improve now.

Most of these are infrastructure projects stuck due to delay in getting various approvals from different wings of the government.

Such delays translate into huge cost-overruns, pushing companies into financial strain crippling their ability to repay the loans. They are forced to seek loan recasts to stay afloat or avoid being downgraded as NPAs.

One of the key poll-promises of the Modi government is to remove such structural bottlenecks in the government’s decision making process and get these projects back on track. Once this happens, these firms hope that they could manage their cash flow situation, even without opting for the recast route. But their revival depends on how much of the projects come back on track.

Similarly, the seeming decline in the pace of bad loan numbers of state-run banks was more because of the sale of stressed assets to asset reconstruction companies in the March-quarter, than a genuine improvement in the asset quality scenario.

“We need to wait at least till the end of this fiscal year to see a clear trend in the asset quality situation. At this stage, it is too early to conclude that we are far from the worst,” said a senior banker, who is involved in the corporate debt restructuring process.

A clearer picture will emerge when earnings of larger banks come in the June quarter.

A lot will depend on to what extent the Modi-government succeeds in eliminating the infamous policy paralysis that gripped the government machinery during the UPA regime, which broke the back of several projects, mainly in infrastructure sector.

For now, there seems to be no respite from the asset quality worries.