Former Reserve Bank of India Governor Raghuram Rajan and former Deputy Governor Viral Acharya have together advised a "deep surgery" for Indian banks by trying to put the stressed firms back on track rather than simply applying band aids of short-term fixtures.
A jointly authored paper by the duo has advocated an overhaul of the bad loan management system, privatisation of public sector banks, and doing away with the Department of Financial Services in government.
Rahuram Rajan and Viral Archarya have argued in the paper that although India has a low credit to GDP ratio, the country's banking system "has among the highest gross non-performing assets (GNPA) to total assets ratio globally." Suggesting three steps to tackle the menace of bad loans, the former bankers proposed:-
1. Out-of-court restructuring frameworks that can be designed for time-bound negotiations between creditors of a stressed firm, failing which National Company Law Tribunal (NCLT) filing should apply.
2. Development of an online platform for distressed loan sales to provide real-time transparency in loan sales.
3. Private asset management and national asset management "bad banks" should be encouraged in parallel to the online platform for distressed loan sales.
Why recognise bad loans?
Explaining the need to recognise bad loans, the duo opines that the first step to deal with bad loans - the key overhang of the banking sector is "an honest recognition of loan losses."
The banks can "put the stressed firm back on track rather simply applying band aids", they say
If banks write the existing loans down, and the promoter as well other stakeholders of a firm, such as local government and tariff authorities, bring in more equity, it (the firm) may have a strong chance of revival.
The former bankers further state that "the promoter, in addition, will be incentivised to try his utmost to put the company back on track. This way, the bank can recover more through an effective restructuring, even if it writes down the face value of its loans."
However, the duo expresses that in order to do the deep surgery such as reducing loan interest rates, converting some portion of the loans to equity, and writing down loans, the banks have to first recognise it (NPAs) as a problem, i.e., they have to classify the assets as NPAs (non-performing assets).
They further enunciate that the NPA classification should be thought of as an "anesthetic" that allows the banks to perform extensive necessary surgery to set the firms back on their feet.
The former bankers state in paper that if banks want to pretend that everything is all right with the loans, then they can only apply band aids such as extending the terms (of loans).
However, if they (banks) want to take a drastic action then that would require NPA classification, which is accompanied by provisioning, as it ensures the banks set aside a buffer to absorb likely losses.
The duo highlight that in case the losses materialise, the banks don't need to write back past provisioning for profits, and if they materialise, then they (banks) don't need to suddenly declare a big loss, the banks can rather offset the losses against the prudential provisions they have made.
The former bankers note that this way the banks' balance sheets would represent a true and fair picture of their health.
The duo also suggest that a timely provisioning also gives bankers the incentive to "deal with the root cause problem at an early stage."
NPAs a stigma
The stigma associated with NPAs in India has very real consequences, Raghuram Rajan and Viral Acharya point out in the paper adding that Indian bankers are particularly "reluctant to make further loans to a firm whose loans have been declared NPA."
This, the duo says, happens even though the RBI has no regulation prohibiting such lending. The PSBs claim that the reason why they hesitate in extending loans to such firms is the fear of being hauled by the investigative authorities.
Hence, the former bankers express that the whole process of recognising and restructuring bad loans is fraught with fear. Bankers don't want to recognise a loan that has gone bad and they don't want to lend to a distressed borrower.
NCLT to the rescue
Raghuram Rajan and Viral Acharya further state in the paper that the National Company Law Tribunal (NCLT) offers a way for the responsibility for restructuring to be taken out of the hands of the bankers. They explain that the NCLT, essentially, appoints an insolvency resolution professional who conducts an auction for the distressed firm and its assets and pays the proceeds to claimants.
Since the tribunal conducts the auction, bankers have been off the hook in deciding how much of a write-down they must take. In the wake of these concerns, an important advantage of the NCLT is that it takes into its fold all creditors of the borrowers while resolving a default.
Given the increasing role of non-bank creditors, such as insurance companies, debt mutual funds, and their respective regulators, in the financing of large corporations, the former bankers note that there is a good rationale "to keep NCLT open as a viable option for restructuring, even during the current pandemic, with possibly tight controls on eligibility of borrowers."