Is Viral Acharya’s solution for stressed assets viable for Indian banks?
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Mumbai: The stressed asset resolution mechanism suggested by the newly-appointed deputy governor of the Reserve Bank of India (RBI), Viral Acharya, might just be what the Indian banking system needs at a stage where it is threatened by a Rs7 trillion bad loan problem.
In his maiden speech as a central bank representative in India at an event on Tuesday, Acharya spoke about creating special structures which are enabled to deal with stressed loans on the basis of the turnaround potential of the underlying company.
Acharya’s suggested mechanism acknowledges that the only real way of removing the stress off bank books is to effect a recovery and resolution in the stressed company. The creation of a private asset management company (PAMC), which will handle the creation, selection and implementation of a feasible resolution plan for quick turnaround, the involvement of two credit rating agencies which rate the company and not the debt issued to them and finally, taking the voice away from the company’s promoters who may implement delaying tactics on a regular basis to retain control, all point at a well thought out strategy to tackle some real issues in the resolution mechanisms that are at play right now.
In case of companies which are far gone and are in need of a more long-term solution, Acharya suggests the creation of a national asset management company with a minority government stake, which would raise debt and manage the asset reconstruction companies (ARCs) and private equity firms that would actually turnaround the underlying company.
This is a departure from all previous RBI measures implemented by his predecessors, such as corporate debt restructuring (CDR), strategic debt restructuring (SDR) and scheme for sustainable structuring of stressed assets (S4A), which are all focussed on protecting bank books from stress.
Under CDR, for example, banks were too concerned about attracting additional provisions, which led them to give two-year interest and principal moratorium to the companies seeking a financial restructuring. While this helped them to extend and pretend that the problem didn’t exist, it did little to help the company streamline its operations. This can be proven by looking at the high rate of failures in the CDR cell, where some very large companies ended up breaching covenants set in the restructuring agreement between banks and borrowers. Of the 530 cases with loans worth over Rs4.3 trillion that were approved for restructuring at the CDR cell as on 31 December, 264 cases with loans worth Rs1.25 trillion failed their restructuring agreements.
In SDR, for example, while the RBI gave banks the power to convert a portion of their debt in stressed companies to majority equity, it did not say much about the nature of conversation with the existing promoters. This meant that bankers spent months negotiating with promoters on possible restructuring options, using SDR as a scare tactic. This actually delayed the process of resolution as promoters would talk about bringing in new investors that would never materialise. Cases like ABG Shipyard and Essar Steel are a couple of examples. In cases where the bankers did implement SDR, there was little impact as buyers were difficult to come by for stressed companies at a high price.
S4A as a mechanism had a high entry barrier in its definition of sustainable debt. The scheme allowed restructuring of companies where the six-month cash flows were enough to service at least half of the funded liabilities—or what the RBI called “sustainable debt”. As companies had been in stress for more than three years, by the time S4A was introduced, it was difficult for companies to have a six-month cash flow that could justify the elevated level of debt. Bankers tried to lobby the RBI multiple times, hoping to lower the minimum sustainable debt limit, so that they may implement in a higher number of cases. But the RBI never allowed it.
Acharya’s suggestions tackle all of these issues and also give leeway to bankers to take crucial business decisions without the fear of being unduly questioned by vigilance agencies, which is a real threat right now.
In his speech, the deputy governor also established his dislike for the much touted “bad bank” option. Although in previous interviews, he discussed the possibility of creating a bad bank in the Indian banking system to house stressed assets from other lenders, Acharya pointed out that he is no more in support of a bad bank-like structure for resolution. He said that asset management companies aimed at stress resolution must not be allowed to become banks, so that their structure remains simple and they become attractive for private investors. The Economic Survey for the year 2016-17, released by the finance ministry last month, pushed for the creation of a bad bank in the form of centralised Public Sector Asset Rehabilitation Agency (PARA) to better deal with stressed assets.
Also read: Designing the bad bank of India
However, Acharya’s suggestions are just that—suggestions. For these to become actual guidelines, the RBI would have to release an enabling notification, which would allow banks to construct these structures and effectively deal with stressed loans. Considering that Acharya is not in charge of the department of banking regulation or supervision at the RBI, it would be interesting to see the direction in which the banking regulator would move to deal with stressed loans.