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NPA ordinance: Letting RBI fight NPA battle is no solution; privatise weak PSBs before time runs out

“Frankly, we have no prior experience to judge this but I believe it is the best option under the circumstances,” said one of the former RBI governors when asked whether the recent ordinance promulgated by the Narendra Modi-government will help resolving the stressed asset crisis in Indian banking sector.

“RBI is respected and feared and so it should produce better results than efforts so far,” he said requesting not be to be identified.

But not many in the financial sector shares this view. In a note on Tuesday, global rating agency, Moody’s made some pertinent remarks about the new NPA ordinance. It said. “These measures (Ordinance) improve the efficacy of NPL resolution mechanisms and are a credit positive. However, they do not address the lack of capital at the state-owned banks, that has prevented them from writing down NPLs to realistic levels. We continue to expect NPL resolution to be a relatively long drawn out process.”

In a way, the NPA (non-performing asset) ordinance is seen as the final act from the Modi-government and the RBI to find an answer to the NPA problem. It has tried many things in the past, but nothing has worked well to crack the NPA problem. Right now, the bad loan scenario in the banking sector can be termed nothing short of a crisis situation with at least 10 percent of the total loans given by banks in the stressed category. This is a conservative estimate that takes into account.



But according to certain industry experts such as former RBI deputy governor, K C Chkrabarty, the total chunk of problematic assets in the banking system would be around Rs 20 lakh crore, much higher than what the official estimates are.

Some of the government-owned banks are in too bad situation with dangerously high level of NPAs. Just yesterday, IDBI bank informed the bourses that the RBI has invoked the prompt corrective action (PCA) framework on IDBI Bank Ltd as its bad loans have surged. The lender has been barred from taking further large credit exposure, hiring and even opening new branches. The corrective action came after gross NPAs of the bank shot up 80 percent to Rs 35,245 crore and it booked a loss Rs 2,255 crore in December quarter and losses mounted. IDBI bank is not the only lender facing PCA.

In the recent years banks like Indian Overseas Bank and private lender Dhanlaxmi Bank too have faced restrictions from the RBI on account of bad business performance. As at end December last year, at least 20 public sector banks (PSB) in India now have their GNPAs above 10 percent of their total advances, six of them above 15 percent and one bank has reported GNPA at 22.42 percent. Among the lenders with highest level of gross bad loans are Indian Overseas Bank (22.42 percent), State Bank of Patiala (19.33 percent), Uco Bank (17.18 percent), United Bank of India (15.98 percent), IDBI Bank (15.16 percent) and Bank of Maharashtra (15.08 percent).

Over 90 percent of the total bad loans in the banking industry is on the books of government-owned banks, which puts the onus of recapitalising these lenders directly on the government. Just to meet the Basel-III norms, government banks need about Rs 1.8 lakh crore by 2019. That apart, the hole created by the bad loans on balance sheets needs to be filled by forking out a substantial chunk of money. If the government fails to do that, state-run banks will have to either shrink their businesses to preserve capital or find investors to raise funds on their own. Except large banks like SBI, not many state-run banks have succeeded in raising large funds from the market for the simple reason that investors are not too keen to approach these lenders with broken balance sheets.

Can the NPA ordinance work to resolve the current NPA mess? For sure, the ordinance is an acknowledgement from the government that bad loan situation needs urgent attention and quick action, which is a positive signal. But, empowering the RBI to involve directly on bad loan cases is unlikely to help. In fact, by passing the job to RBI, the government has put too much at stake. If RBI fails to make a difference on the NPA scene despite the additional power, the institution will risk losing its face. This is because banking business is predominantly the job and expertise of a bank, not the regulator.

Banks lend money, monitor the repayment and act to recover money from the defaulter. A lot of this is based on the banker-borrower relation and viability of a particular proposal. When the RBI issue directions to bank on a specific case, there is a possibility that these aspects concerning the business of banking will be overlooked. Also, large scale bad loan resolutions will also require capital support for the bank. Can the RBI assure this to any bank? Also, the RBI will face questions on conflict of interest being the regulator and a party involved in the business.

Remember, the RBI has already tried multiple measures to tackle the bad loan situation. It has tried corporate debt restructuring (CDR), 5:25 scheme, strategic debt restructuring (SDR) and, the scheme for sustainable structuring of stressed asset (S4A)—all these have largely failed to resolve the problem of sticky assets. The insolvency code empowers the bank consortium to wind up a company if majority lenders agree. Passing that power to the RBI wouldn’t do any additional help.

According to Moody’s, the reason for the limited success of the various regulatory measures so far is that they do not address two related structural factors. First,
“the operating environment in key stressed sectors remains quite challenging. For instance, in the power sector, which is the biggest stressed sector, plant load factor remains at multi-decade lows, leading to projects run at much lower capacity than originally assumed in the project financing. Also, the actual cost of project completion has often been much higher than originally planned. Operating conditions in other stressed sectors such as steel and construction remain challenging as well, although not to the extent seen in power,” Moody’s said.

Second, “in part because of these challenging operating conditions, the market value of stressed assets is typically much lower than what the banks currently reflect on their balance sheets. Hence, successful resolution, either by through debt relief or asset sale, will require banks to take a big hit when they write-down the value of these assets to market value. However, the state-owned banks' weak capital levels mean that they do not have the capacity to take these sort of write-downs,” the agency said.

With the fundamental factors that resulted in the build-up of bad loans remaining, things are unlikely to change in the banking sector. As Moody’s points out, bad loan resolution will take time and the RBI’s direct involvement is unlikely to bring out any miraculous results. More importantly, once the bad loan clean-up is done, the core problem that will haunt banks will be to find massive amount of capital. Considering the fiscal situation and the past evidence, the government will not be able to fill this gap.

The better alternative is to privatise these banks and let them compete in the market. The fact that majority private banks have managed to stay unhurt in the bad loan crisis compared with state-run banks show that there is merit in government letting go of the control of these lenders. This will also empower these banks with long-promised autonomy. If the Narendra Modi-government is serious in its intent to save ailing state-run banks, it should look for radical reform steps to save the banks and initiate the privatisation process without delay. Time is running out fast.

Updated Date: May 10, 2017 13:04 PM

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