RBI’s message to bankers, wily promoters: Call a spade a spade; don’t fool the regulator and investors

The Reserve Bank of India’s decision (read here) to scrap multiple schemes that banks use to restructure corporate loans and asking lenders to comply with a time-bound resolution of stressed assets will instantly do two things. One, wily promoters will not be able to collude with their banker friends anymore and keep their bad loans technically standard forever. In banking parlance, this practice is called ‘evergreening’. Second, in the same way, smart bankers cannot show their balance sheets healthy before investors and promoters when in reality those are not. The RBI has insisted on a time-bound resolution of stressed assets and closer, more frequent monitoring of high value loans to avoid future bad loan piles. All stressed asset cases above Rs 2,000 crore needs to be resolved within a period of 180 days. These norms, if followed in letter and spirit, can work wonders for the Indian banking sector and will gives confidence to investors that even the ongoing bad loan clean-up exercise will not be another futile exercise. More critically, the central bank has warned wrongdoers among banks that monetary penalties and higher provisions will be imposed if banks resort to evergreening. This is certainly a clear message to bankers and corporate promoters, who have been fooling the regulator by cleverly using short cuts for a long time. To understand the current scenario, let’s look at how things are done now: Despite the Insolvency and Bankruptcy Code in place, which basically asks banks to resolve a stressed asset within a maximum of 270-days, it offered the much needed-confidence to investors that NPAs will not be carry forward for several years locked in litigation. But even then, there were several schemes that offered loopholes to escape from this time-bound resolution. These include various loan restructuring schemes such as Corporate Debt Restructuring, Sustainable Structuring of Stressed Assets or S4A, Strategic Debt Restructuring, and Flexible Structuring of Existing Long Term Project Loans. With the change in the framework, all these schemes are disbanded. [caption id=“attachment_4338193” align=“alignleft” width=“380”]  RBI. AFP image.[/caption] With the RBI finally closing loopholes for future cases of evergreening, the following steps taken by the central bank and the central government make sense now: The bad loan clean-up exercise: The RBI initiated asset quality review (AQR) in 2015 and stipulated rules for early recognition of stressed assets. Under the governorship of Raghuram Rajan and in coordination with the government, the RBI asked banks to identify and recognise all bad loans by March 2017. Till then public sector banks (which account for 70 percent of the banking system and almost 90 percent of bank NPAs) were happily ever-greening bad loans of influential, politically connected promoters through technical adjustments. The infamous corporate-political nexus worked in full swing. The bad loans pile-up was built in the banking sector over a period of years during the boom time when banks engaged in careless lending to balloon their loan books and beat competition. There was very little care attached to prudential norms and quality of lending. Banks began this painful exercise and started reporting huge NPAs in subsequent quarters, which caused high provisions and hit their earnings as well. Banks could not meet the March 2017 deadline, but the exercise continued thereafter. On account of high provisions, banks’ earnings continued to take a beating. This reflected in their stock prices as well. The big question still remained: What if, after all this painful bad loan clean-up exercise, banks continued to build-up another round of NPAs? The birth of the Insolvency Code gave some hope but different kinds of loan restructuring schemes continued. The scope for these schemes has now narrowed considerably with RBI overhauling the norms. The Rs 2.11 lakh crore bank recapitalisation programme: Shortly before the 2018 Union Budget, the Narendra Modi-government announced a massive recapitalisation programme for government-owned banks which constitute 70 percent of the assets in the Indian banking industry. Of this, a sizable chunk, Rs 1.35 lakh crore was designed to come from bank recapitalisation bonds and the remaining from a mix of market borrowing and scheduled annual capital infusion plan. By far, this was the biggest-ever capital infusion programme state—run banks have ever received since nationalisation. But, again the question was, whether the government was throwing good money after the bad by doing this. With the fundamental reasons that have caused distress in banks—lack of autonomy, management inefficiency, vulnerability to corporate-political nexus—remaining as they are, can capital infusion be seen as a cure to banking sector’s ills? To be sure, the RBI overhauling the bad loan treatment is not an answer to the problems faced by public-sector banks. But, it partially addresses the problem for sure. At least banks won’t resort to evergreening to keep bad loans as technically standard. To sum up, by scrapping a number of loan recast schemes and insisting on a time-bound resolution for high-value stressed assets, the RBI has hit the bull’s eye that can change the banking sector as we know it. The message from the regulator is clear to banks and wily promoters—Call a spade a spade.