Treating all debtors the same, including those with scope for turnaround, is bad for banks and the economy
There can be no doubt that banks need to go after the non-performing assets (NPA) vigorously so that the moral hazard of wilful default does not get hard-coded into the DNA of borrowers.
Banking thrives on the delicate psychological infrastructure of public confidence. One should also bear in mind that one of the most essential ingredient of growth is risk-taking capacity and entrepreneurial zeal.
The current hysteria being created by media and the sudden near-choking actions of the RBI towards NPA recovery seem to overlook the fact that we need a balanced approach to recovery even while preserving the above two.
Reasons for bad loans
The current stock of NPAs is the result of court actions of cancellation of licences, government not keeping its word on contractual obligations, global commodity price movements, low equity base in India, irrational exuberance in sanctions and a lackadaisical approach in the past, free-trade agreements (FTA), a sudden sinking of the growth table from 8-9 per cent to 6-7 per cent with services taking a greater share, etc.
Of these, the Asean FTAs have played a large part in pushing many units to involuntary defaults. According to one estimate, when all ASEAN countries implement their FTA commitments with India, India’s exports to them are supposed to increase by 21 per cent while India’s imports from them was slated to increase by 59 per cent (C.Sikdar and B. Nag, 2011,Impact of India-ASEAN FTA).
Surprisingly, Asean FTA, effective January 2010, remained largely unnoticed till the last leg. When the import duties on many end products became zero per cent from 2.5 per cent in 2014, it became a tipping point for the media, traders, and even the overseas exporters.
The cumulative lag in its impact weighed in heavily all too suddenly. This put the domestic manufacturing industry’s prices on import parity and several industries became uncompetitive or saw their margins shrink. In any case their ability to pass on input cost inflation became restricted. Due to this, the growth rate in several Indian manufacturing sector has sharply come down from 7-9 per cent to 3-4 per cent. This has elongated the pay back of several projects from 6-7 years to 10-12 years.
A moderated approach
Banks should carefully segregate stressed credits into (a) where Return on Capital Employed (ROCE) is still more than Cost of Capital (COC). This would indicate that the credit is still viable but less liquid than earlier planned, and (b) where ROCE is less than COC, where the feasibility itself in question.
In case of (a) the RBI should allow one-time re-scheduling of loans in line with the revised economic assumptions and the elongated paybacks, with adjustments in credit spreads, but without strangulating either the clients or banks by provisioning.
Such cases should not be reckoned as NPA in view of the general objective of maintaining a conducive atmosphere for investment. They should not be allowed to erode the confidence in our banking system and preserve the capital base of banks.
Most of current stipulations seem more appropriate for Type (b) cases. The combined might of the legal system (with its slothful, apologetic approach) and existing regulations is the weakest in cases involving immoral and wilful defaults. Immediately after the crisis of 2008, it was found that the CEOs and traders of investment banks had appropriated for themselves huge bonuses from questionable practices and structures.
The Swiss and the Swedish authorities, instead of protracted legal battles, arm twisted them to pay up a substantial part of their ill gotten gains, threatening them with the might of the State which yielded optimum and quick results.
Given that the top 60-70 cases would cover nearly 80-85 per cent of our current NPAs, the regulator, the government and the banks might do well to take lessons from such an approach and jointly ‘arm twist’ a settlement.
This approach might involve transfer of ownership in Type (b) cases to others in the industry who have competitive strengths in manufacturing, technology or distribution to make a less viable unit to fully viable one. Central Banker should have ideally asked for easy exit norms including the court procedures, automatic transfer of licences and permits instead of just concentrating on provisioning alone.
Banks should also agree on norms for lending for takeovers and mergers which is taboo as of now at least for cases involving share purchase, even if the acquirer has to pay for liabilities simultaneously.
Overly cautious approach
The contrasting approaches of the Fed to 2008 crisis as against the current scene in India is interesting. The 2008 crisis was caused by individual excesses and born of instruments created by outlandish models.
Professional excesses were writ all over and unjustified transfers of wealth humongous. Yet their approach was to save the system and public confidence and many of the sins were forgiven or forgotten, despite the effectiveness of their legal system.
Our strangulating approach of ‘one prescription whatever the diagnosis’ seems destined to manufacture a crisis out of what is at worst a matter of serious concern. This, when an accommodative monetary policy is the need of the hour, with the bulk of the economy and manufacturing sector struggling and growth and employment addition far below potential.
The excesses of strangulation can be gauged in the light of the equity that RBI holds in relation to its total balance sheet size. RBI’s ratio in this regard is the second highest in the World at 32 per cent (next only to Norway at more than 40 per cent).
The same stands at a mere 2 per cent for the US and UK. There is a clear case for a more nuanced and segmented approach, appropriate solutions for each class of cases, besides of course a re-look at the real interest rates which are at historic highs for many sectors, stubbing out any entrepreneurial spurs in the affected sectors. The high equity component in the balance sheet should be a source of comfort and assurance of the system; unfortunately RBI does not seem to know its strengths.
An edited version of this was published on March 28, 2016 in The Hindu Businessline. Link: http://www.thehindubusinessline.com/opinion/going-overboard-on-npa-recovery/article8406146.ece