The global financial crisis of 2008 holds important lessons for banking regulators around the world on timely exit from regulatory forbearance policies, the Economic Survey 2020-21 has said.
The continuation of forbearance policies has unintended and detrimental consequences for banks, companies and the economy, the Survey said, adding that the Indian banking sector was a witness to it after the 2008 crisis when a delayed discontinuance of forbearance regime led to non-performing assets (NPAs) shooting up.
The current regulatory forbearance for banks post COVID-19 pandemic involves relaxation in norms for restructuring assets, under which restructured assets are not required to be classified as NPAs, lower provisioning and capital requirements , lower risk weightage for assets, among others.
The Economic Survey has laid down five ground rules for RBI to end the current forbearance regime.
Setting a threshold of economic recovery for exiting forbearance policies
The Survey suggested that policymakers should lay out thresholds of economic recovery at which forbearance measures will be withdrawn. This could be a GDP level of 5 per cent or higher.
It said the thresholds should be communicated to the banks in advance so that they can prepare for the same. "Prolonged forbearance is likely to sow the seeds of a much deeper crisis. Besides, forbearance should be accompanied by restrictions on zombie lending to ensure a healthy borrowing culture."
Immediate asset quality review of banks
The Survey advised that a clean-up of bank balance sheets is necessary when forbearance is discontinued. "Asset quality review exercise must be conducted immediately after the forbearance is withdrawn," it said.
The asset quality review must account for all the creative ways in which banks can ever- green their loans. "The banking regulator needs to be more equipped in the early detection of fault lines and must expand the toolkit of ex-ante remedial measures."
Capital infusion after clean-up
A clean-up generally means higher provisioning pressure from profits and also higher NPAs. Such an exercise, if not accompanied by mandatory capital infusion, exacerbates bad lending practices, the Survey said
"Expecting banks to get recapitalized on their own on account of economic recovery may not be prudent. Therefore, a clean-up exercise should be accompanied by mandatory recapitalization based on a thorough evaluation of the capital requirements post an asset quality review," it suggested. In a banking system dominated by public sector banks, the government has to come forward to aggressively recapitalise the banks, it said.
Focusing on quality of governance
Apart from re-capitalising banks, it is important to enhance the quality of their governance. "Ever-greening of loans by banks as well as zombie lending is symptomatic of poor governance, suggesting that bank boards are 'asleep at the wheel' and auditors are not performing their required role as the first line of defence," the Economic Survey said.
To avoid ever- greening and zombie lending following the current round of forbearance, banks should have fully-empowered, capable boards. "Sound governance is a key metric to ensure that banks do not engage in distortionary lending post capital infusion. The regulator may consider penalties on bank auditors if ever-greening is discovered as part of the toolkit of measures. This would thereby create incentives for the auditor to conduct the financial oversight more diligently," it said.
Strengthening legal infrastructure for loan recovery
The Survey suggested strengthening of legal infrastructure for recovery of loans. The Insolvency and Bankruptcy Code (IBC) has provided the powers to creditors to impose penalties on defaulters. However, the judicial infrastructure for implementation of IBC, which comprises of debt recovery tribunals, National Company Law Tribunals and appellate tribunals, should be strengthened substantially, it said.