NPA and Government: What options does government have before 2019?

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Introduction

Non-Performing Assets, Defaulters, Scams, Frauds etc. are headlines under every media source in India today. You all know, this is not new. Banks writing off loans, making provisions, whole financial system under stress – this is also not new. What is new then? Now, the new is that the citizens of the country are asking questions.

Questions are being asked that how a normal resident can’t even get a loan while the rich are fleeing the country with the money. Question of how we are paying more bank charges and interests on our small loans, yet the rich are just defaulting almost on regular basis? These questions are defining the mind frame of a common man in the country today.

And with the common man comes the government. And in this case, the timing is so delicate, what comes as bonus is elections. So how does the government deal with this NPA fiasco meanwhile changing the new built perception in the mind of common man just in time with the elections around the corner?

How big is the problem?

Amount wise NPAs in India are above INR 9 lakh crores, nearly 1.5 times of the market capitalization of Tata Consultancy Services (the biggest company in the country by market cap). This is the cost which the Indian banking system has to take, absorb and survive. Out of this total NPA amount, more than 80% of this is with Public Sector Banks. As per a report, leading corporates account for approximately 77% of gross NPAs of the PSBs.

As per the financial stability report of RBI released in December 2017, Stress test suggests that in the ground level scenario, Gross Non Performing Assets (GNPA) of the banking sector may rise from 10.2% of gross advances in September 2017 to 10.8% in March 2018 and further to 11.1% by September 2018. Further, RBIs biannual financial stability report suggests, while PSB have seen a rise of 17% in NPAs, private players have seen a rise of 40.8% in the same period.

On top of this are scams and frauds. Recently, a lot of them have been unearthed. There have been lots of surprises here too. But nonetheless, all of them are in the same basket. Cherry on the cake is this financial crisis is impacting on other fronts too. The share market is already under stress. It has shredded more than 1000 points in three working days post Holi. There has been anxiety in the minds of the depositors too. They have been withdrawing money from these banks. This is reducing liquidity from the system. Already suffering from job woes, this problem is just amplifying it.

What are the options the government has?

To start with, as the Economic Survey of 2018 suggests for Short Term - resurrecting Indian banks requires four Rs — recognition, resolution, recapitalisation and reforms.

Recognition - Recognition hasn’t been completed yet. The banks are still recognizing bad loans and the stressed advances ratio, gross NPA ratio and the net NPA ratios are still escalating. Banks’ bad loan provisions haven’t kept pace with the fast rising NPAs. As of September 2017, the average provision coverage ratio for all banks stood at about 44%. RBI has said that banks would have to take more proactive steps to report large corporate loans overdue for less than 90 days and abruptly discontinued older schemes to restructure corporate loans. Also, as per finance ministry directive, all NPAs above INR 50 crores will be checked for ‘possible fraud’ and if there are any violations of law on money laundering and the Foreign Exchange Management Act.

Executive Directors and Chief Technological Officers of the PSBs have to prepare a blueprint for combating increasing risks and to take preemptive action and identify gaps/weaknesses to gear up for rising Ops and Tech risks.

Resolution - The resolution mechanism under National Company Law Tribunal (NCLT) will help the banking sector to book the defaulters. The new Indian Bankruptcy Code (IBC) has provided a resolution framework that will help corporates clean up their balance sheets and reduce their debts. Companies can be referred to (NCLT) under this. As per the reports, more than 400 cases have been referred to NCLT. The worry here is, no matter what, once a company is referred to NCLT, the bankers, lenders have to brace themselves for a haircut. Last report suggested that lenders may have to take between 60 to 90 percent haircut. This imbalance brings a severe strain to the financial cycle.

In cases of big companies, this process has yielded its first result as well where Tata steel took over Bhushan Steel and the bankers and lenders were saved from taking a major haircut.

To recover outstanding loans, other existing measures are a few legislations including the IBC (Insolvency and Bankruptcy Code), the SARFAESI (Securitization and Reconstruction of Financial Assets and Enforcement of Security Interest) Act, RDDBFI (Recovery of Debts due to Banks and Financial Institutions), PMLA (Prevention of Money Laundering Act) etc. Debt Recovery Tribunals (DBT) also has been set up to fast-track proceedings.

RBI also pushes for recovery through SDR (Strategic Debt Restructuring). It also has weekly/monthly reporting done by banks for accounts more than INR 5 crores to the Central Repository of Information on Large Credits (CRILC). Further through SMA (Special Mention Accounts), it monitors the stress on the loans advanced.

The latest addition to these measures is the Fugitive Economic Offenders Bill, which has been approved by the cabinet. This bill is intended to stop economic offenders and defaulters from escaping the country and the law.

Recapitalisation - In another critical move, the government announced a recapitalization package of a whopping INR 2.11 lakh crores (about 1.2 percent of GDP) to strengthen the balance sheets of the public sector banks (PSBs). There are approximately 14 big corporate accounts which account for more than 50% of exposure of PSBs in NPAs. The banks hope and believe to recover money by selling and monetizing the assets of these NPAs but it will be a while before it, considering the length and breadth of our law system. This increases the need for recapitalisation. The Financial Resolution and Deposit Insurance (FRDI) Bill is also being introduced in order to help banks in recapitalisation.

Reforms – This has been a big part of any debate which have took place in the light of recent incidents. Suggestions like Privatization of PSBs, Mergers, Reforms by P.J. Nayak committee, etc. have already been doing rounds.

As a part of reforms, the government has decided to close or merge 35 overseas operations of PSBs. Further, the government will examine all 216 overseas operations, out of which 69 have been already identified by the government where it will examine to rationalize the non-domestic set up and determine whether they are viable to continue or not. As per Rajeev Kumar, Secretary at the Department of Financial Services (DFS), this will be done without affecting international presence of PSBs in these countries. This is being called as Action as per Reforms Agenda.

Another reform suggested is – Privatisation. Like what Indira Gandhi did in 1970; Nationalization of banks, maybe time has come to again privatize the banks. This helps in increasing efficiency, brings in more accountability. But a major concern here is that Privatisation will lead to shelving of social sector lending or priority sector lending as it is called. This sector includes majorly the agriculture sector. The government could keep the priority sector to itself, and work this option out with different alternatives.

Another part of reform is concurrent audits – In the recent series of frauds and scams, the work of auditors was also highlighted and was found ineffective as the audit wasn’t able to properly report the red flags in the system. The government is introducing FRA (Financial Regulatory Authority) to keep a check on the work of the auditors and built a maker checker relationship. This would bring in more accountability and proper red flagging of serious issues.

HR reforms – This could be an effective tool for the government if used and implemented correctly. This could include bringing in more professionalism in PSBs, linking the employees’ incentives to their respective performance. More effective whistle blower policy, policy for misconduct could also be included in these reforms.

Working of the banks – The banks need to bring in change in their style of working and bring more effectiveness. To start with, bringing in more integrity will boost the morale of employees. In case of operations, more strict vigilance and credit monitoring is the upfront need for the banks. Genuine failures require proper handling and formulation of an exit policy. Also, banks need to strengthen the internal controls and audit mechanism.

These are the 4 R’s which can sum up the need, want and demand of the banking sector right now.

In the past 2-3 years, the banking sector has suffered a lot. Poor global economic cycle, demonetization, reforms kicking in, these activities when impacted the financial sector, they were bound to impact the banking sector as it is one of the fundamental pillars of society in India. And no one can remember last big restructuring or reforms for the banking sector in one shot. They all came in bits and pieces. What happened might have been triggered by the recent frauds, but it was inevitable. The government took it as an opportunity and has brought in reforms and recapitalisation to give a new start to the sector.

So overall in my opinion, although there has been a lot of initiative and action taken by the government on this front, there might be another storm which the banking sector might have to scrape through before any of these reform results kick in.