A faster one time debt restructuring

A faster one time resolution plan

This appeared in Businessline today. https://www.thehindubusinessline.com/opinion/a-quicker-way-to-do-one-time-loan-resolution/article32489800.ece

RBI has been both sensitive and fast in dealing with Covid crisis. It has constituted a committee of eminent persons under KV Kamath with a tight and functional deadline. Laudable as it is, one requires a non-discriminatory and non-discretionary yet speedy mechanism at this time to tackle the crisis.

The committee will no doubt come up with a valid and justifiable set of criteria for onetime restructuring. This may have some industry wise criteria, some client-health specific criteria, some bank-client history specific criteria.  Whatever be the recommendations of the committee, its guidelines would involve application thereof which would call for discretion by bank officials at different levels including at Board level in major cases.  

This process involves time – to get revised projections from clients and justify such restructuring – to write up the proposal and present before the sanctioning committees at whatever levels, documenting such approvals, new amendment agreements, etc. involving great lot of efforts and lead times.

There is a great deal of inertia induced by the recent spate of financial frauds discovered and the way it has been dealt with in full public view.  The trouble with such ‘exemplary’ punishments is it affects the psyche of the honest (who make the near total majority) much more than the people who game the system. The net effect is a definite slowdown in systems and risk aversion.

Our public sector systems depend too heavily on the top for decision making. Most such functionaries are closer to retirement and prone to risk aversion, except where possibly the decision making is collective like at Board or committee level. Between protecting his borrower and their own pensions, they can’t be faulted for preferring their self-interest.

A faster approach may have been as follows:

  1. All principal re-payments due on loans could have been slid down by a year and all dates (beyond Mar 2020) in all existing agreements (as of March 2020) could have been deemed to read as one more year than mentioned in the repayment schedule. For example if the repayment was to be in 2020,2021, 2022, they should be mandated to read as 2021, 2022 and 2023 respectively.
  2. All interest payments due during the year, if the clients are not able to service could be accumulated and converted into a loan for 3 years with a small increment of 1% over the present documented rate, which clients may choose not to avail.

These could be legislated so amendments to individual loan documents made unnecessary. That will leave no discretion and hence neither bribe seeking/offering would be possible nor would risk aversion be necessary. This would be the fastest to implement. Such a systemic boldness has been demonstrated by Brazil thrice during the last century but in a different matter when they cancelled the last 3 digits in all their outstanding currencies overnight (like all 10,000 Reals were to be read as 10 Reals from next day morning). 

Banks would be rid of NPA and provisioning worries. Their cash flow for relending may be diminished but they are stuck anyway for both lack of inflow and not many credit worthy clients to lend.

It would still leave foreign loans. But the foreign banks are quick on such decisions and generally lot less cowed down by personal fear psychosis.

Firms which have been profitable even after Covid impact may not have to suffer any credit downgrades if the Credit Rating agencies sensibly factor in the match the obligations with the scenario after Covid subsides. Such firms may face the dilemma whether to seek re-scheduling or not for fear of stigma by rating agencies and lending banks in future. It would save them such blushes.

Those who have declared losses in the last 4 months would gain by interest moratorium and may have to deal with residual concerns.

If the Government could also sanction changes in Accounting Standards to capitalize all interest, forex losses and may be even Covid losses (even if not funded by banks), it would help in preventing many firms from breaching ratio covenants in most cases. Ratio covenants play a heavy role these days in decisions to lend, rating, and determination of rates.     

a Mix of Inflation and devaluation could tame Covid financial losses.

Overcoming Covid created financial crisis with a mix of devaluation and Inflation

V Kumaraswamy

The financial jolt from Covid virus should surely count as 3-sigma event or perhaps even 6-sigma. The global meltdown 2008, East Asian Crisis and Dotcom bubble seem to stand nowhere near this. They didn’t chock the physical economy as much as Covid. While the final loss count would depend on how long Covid continues, assuming it continues till end of September at the very minimum it is likely to shave off our GDP by 10-12% compared to previous year, leave alone the lost growth. That’s is a whopping Rs 20-25 lac Crores. RBI’s recently announced onetime restructuring addresses the liquidity issue but laves open the solvency issue completely open.  

Who should bear the Loss?

There is a huge systemic economic loss during Covid19 and we have to devise the least harmful way to share it between government, business, banks and people.

The Government bearing the losses will amount to about 3-4 years’ fiscal deficit in one go – simply too disastrous to the fiscal health. Government should focus more on revival through new investments and bail out others only to the extent it helps it in its effort of revival: it should limit its support to only the vulnerable sections of people (say income-wise bottom 20%) and firms. It would do well not to aggregate all the losses of private individuals with itself by bailing them out. Where would it load such losses? It ultimately has to load it back on the citizens through GST or Income taxes. The Government should therefore focus on the poor mainly by way of food security and medicare.

Businesses – both big and small – have accumulated a more than fair share of the losses and it will soon transmit to banking system thru credit downgrades. Many of them will become economically viable once the economy gets going, but have to service the additional losses accumulated during Covid period with their existing assets. When this inevitably transmits to the lenders, many a bank will suffer and the financial system might be too debilitated to support the revival investments required.      

We need to find novel ways of spreading the losses over a fairly long time. Examined below is one such measure of using a mix of devaluation and inflation by using forex reserves which is built for extreme contingencies but remains side-lined due to oppressive orthodoxy and perhaps lack of boldness.   

Suggested way by using Forex Reserves

India should de-value its currency by 12-15%. There will be a huge valuation gains on Forex reserves to RBI – may be $ 50-60 Billion in INR equivalent (say 3.5 to 4 lac crores). As law stands today, this unrealised valuation gain cannot be distributed as dividends to Central Government. But if we can be bold like US Fed Chairman and Treasury Secretary during 2008 crisis, and say what is not expressly prohibited is deemed permitted, the gains can facilitate RBI investing an equivalent amount as Equity in banks upto 15%. The banks can be permitted to buy back the equity so issued whenever Banks meet some designated criteria in the next 5-7 years. SEBI norms should be relaxed to facilitate this.

Alternatively, RBI can directly liquidate 10-15% of its forex $ assets and subscribe to the banks’ equity. The level of one year’s imports is too wasteful earning 1-2% returns (much below their costs) and if it is not used at this 6-sigma like crisis, what is its use!  

Use by Banks

This equity to banks can be used to write off (or provision) 10-15% of loans to all MSMEs, Mudra loans, and select other segments the criteria for which can be defined by a reputed committee following of whose directions can absolve the bank officials of any wrong doing and post retirement raids. Alternatively, the interest for one year can be written off for qualifying units – may be for all those who are paying the salaries as evidenced by withdrawals or interest for 12 months from date of restart, thus incentivising restart. The amount so written off can be recovered by hiking interest rates by about 1-2% over the next 5-7 years, enabling the banks to return the equity to RBI.  

Hopefully the Rs 3-4 lac crores write offs if properly targeted will save many bankruptcies. This in turn may save banks thus avoiding chain defaults and degrades both at corporate and bank levels leading perhaps to India country downgrade.

The central government’s efforts for avoiding downgrade by keeping a tight fist on stimulus spends as is seen now, can come to naught if many businesses go belly up leading to bank downgrades. So better to save the situation even if unorthodox.

Thus RBI can front end the losses through valuation gains. Banks can carry the write offs temporarily. And recover through 1-2% additional interest and ½% additional interest towards Covid interest fund. This will compensate the banks for their one time write off and the banks can pay back RBI with the money so recovered, thus completing the cycle over 6-7 years.