In June 2008, Indian public sector banks that account for 73% of the country’s banking assets cleared some 43 million applications from farmers to waive and recast Rs65,318 crore of loans. The blueprint for the loan waiver, the biggest undertaken in India, was drafted by then finance minister P. Chidambaram in the Union budget for fiscal 2008-09. About 36.9 million small and marginal farmers received a waiver of all their debt; 5.97 million had 25% of their loans written off.
Eight months down the line, in March 2009, the banking industry once again had to sift through millions of applications by borrowers for yet another loan recast. This time, the initiative was taken by the central bank to shield companies as well as individual borrowers from the impact of the economic downturn. The deadline for filing applications for the loan recast was 31 March, and banks need to settle such cases within three months.
By a conservative industry estimate, between 3% and 4% of the total loan assets of Indian banks is likely to be recast. Since the outstanding loan portfolio of the industry, as of 13 March, was Rs26.9 trillion, Rs80,000 crore to Rs1.07 trillion worth of loans will be recast. This will make it the biggest loan recast ever undertaken by the Indian banking system.
Under normal circumstances, a loan becomes sticky when the borrower, be it a company or an individual, fails to pay interest on it for 90 days. Once a loan turns sticky, banks are required to provide for it in their balance sheets and the amount set aside depends on the nature and length of default.
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As the global credit crisis deepened and spilled over into the real economy, including India’s, after the collapse of Wall Street icon Lehman Brothers Holdings Inc in mid-September 2008, the Reserve Bank of India (RBI) allowed banks to recast all loans, including their exposure to commercial real estate. In fact, banks were allowed to recast loans not once but twice before 30 June except for those given for commercial real estate, capital market-related activities such as buying shares, and personal loans.
While banks can recast on their own all small loans, given to small and medium enterprises and individual borrowers, relatively larger loans of Rs10 crore and above need to be referred to the corporate debt restructuring (CDR) cell, a mechanism that was put in place in 2001 when some large companies, particularly in the steel sector, got into trouble following a sharp drop in demand and prices. At the CDR cell, the recast of any loan needs the support of 60% of creditors by number and 75% of creditors by value.
Till fiscal 2008, 219 cases were referred to this cell, involving Rs94,735 crore of debt. The cell rejected 29 cases while 16 were pending. In other words, 174 firms got Rs84,714 crore of debt restructured at the forum, and 43 of them actually cleared their dues to banks. With increased sales and profitability in the past few years till fiscal 2008, on the back of an economy growing at about 9% annually, those companies that had got their loans restructured at CDR were able to clear their bank dues aggressively. There was also a dramatic improvement in the quality of banks’ assets, with the average net non-performing assets of Indian banks dropping below 1% of their loan books in 2008.
In fiscal 2008, only 10 cases were referred to the CDR cell, involving Rs3,045 crore. A slowing economy and a slump in consumer demand have taken their toll on the health of companies.
In 2008-09, 33 cases were referred to the CDR cell, involving Rs7,672 crore. While these cases are being dealt with in the cell, in which chief executive officers of top Indian banks are members, individually, banks are dealing with millions of borrowers and in some cases, their exposure could be as little as a few thousand rupees.
There are many ways to recast a loan. It can be done by giving a fresh loan to tide over the current cash flow problem (for a company) or a moratorium on payment (for a home loan or auto loan in cases where the borrower has lost his or her job). Banks can also cut interest rates.
For the time being, it is a win-win situation for both the banking industry as well as the borrowers because there will not be any deterioration in the quality of assets of banks and borrowers will get time to repay loans. There are, however, critics of such a massive recast.
According to them, the entire exercise is nothing but an attempt to postpone the inevitable—cosmetic surgery that will help banks protect their balance sheets and profitability for a time.
Ultimately banks’ bad assets will grow as RBI cannot ask them to recast loans for a third time. This will force the rating agencies to downgrade Indian banks. Indeed, this can happen if the economic downturn continues. This is a gamble RBI had to take because it had no choice. If the economy starts looking up in the second half of 2009-10, both banks and borrowers will be spared a major embarrassment.
Tamal Bandyopadhyay keeps a close eye on all things banking from his perch as a deputy managing editor of Mint. Please email comments to firstname.lastname@example.org