In the six months that elapsed between the Reserve Bank of India (RBI) setting up a working group (WG) on norms for debt restructuring and the submission of its recommendations, the levels of impairment and restructured debt have reached alarming levels.
Current estimates this fiscal point that more than Rs 2 trillion of corporate debt is being restructured. In addition to the corporate debt restructuring (CDR) mechanism, there is also a generic restructuring that banks carry on within norms of RBI. Both categories are conceptually distinct from the non-performing asset category (NPA) but operationally they are quite close to it.
The working group, interpreting its mandate in a social rather than a macroeconomic context, has come up with recommendations that seek to ratify and condone existing restructuring even as it makes new restructuring more expensive.
As it stands now, the gross NPA figure of about 3% includes recoveries. If the figure is taken net of recoveries, as it should be to take into account fresh slippage—which has been higher than credit growth--the banking system is closer to a level of 5% NPAs. This takes the stressed assets in the banking system--restructured plus the NPAs—close to 8%; probably the highest there has ever been in Indian banking.
Operationally, what makes it worse is the anecdotal evidence that a lot of the restructured assets are being ever-greened by the banks to show low levels of NPA. It is this that seems to underlie the continued robust growth in bank credit.
In this context, what sense does it make to follow a calibrated approach suggested by the working group? Or the suggestion of moving to internationally accepted norms in two years from now? This would make sense only under one assumption: a speedy economic recovery over the next two years. This by RBI’s own forecasts and statements is most unlikely.
By increasing the provisioning requirement on restructured assets that have become standard from 2% to 5% over two years, it calls into question the “standardization of restructured assets” and mitigates their slippage risks.
In fact, it is not addressing the wanton restructuring at all and indeed in some way condoning what has already been done. The problem of the stock of restructured assets is being allowed to ferment and aggravate, though new restructuring is being made more expensive.
As regards CDR, the suggestions are a reaction to the existing high-profile cases. The WG has neither understood the macroeconomics that underlies the desire of promoters to swap their equity for debt nor the lack of expertise of banks in managing issues related to equity.
Two things could have been suggested; one to permit banks to park or further sell such equity to private equity firms. This could, in theory at least, have infused expertise and ensured that the promoters were serious about a turnaround.
A second step would have been to bring this equity under the capital market exposure of banks. It would put a natural cap on the kind of restructuring that they resort to.
As far as prudential norms are concerned, it is high time RBI reverses what it had done two years ago. The source of the problem lies in the retrospective relaxation of provisioning norms by RBI, a move that was neither prudent nor progressive.
After 30 September 2010 banks were not required to maintain NPA coverage of 70%. Operationally, this meant that for assets impaired after 30 September, banks will just follow the standard capital provisioning requirement.
It was this dilution that gave banks virtually a go ahead to substitute profits for provision. That happened during an adverse global and domestic macroeconomic situation.
It is time to bring back the well-thought-out 70% floor of NPA coverage that added strength to the banks and stability to their bottom-lines. The other source of the current problems is the sector specific restructuring permitted by RBI about two years ago. At that time, RBI was betting on growth, hoping that all these restructured loans would turn around with growth. That has not happened. So far asset quality has been seen more as a bank specific issue rather than a systemic problem. Now, even as a high loan concentration is posing a problem for some individual banks, the sectoral over-leverage is threatening the banking sector as a whole.
From a macro perspective, an over-leveraged sector and not over-leveraged companies is the problem: 85% of the total NPAs of the banking sector are in real estate, infrastructure and priority sector lending. This is the root cause of the incipient banking crisis.
The solution to this is to follow a relatively easier monetary policy, along with much tighter prudential norms regime. This will ensure better utilization of credit along with greater strength to face deterioration in asset quality which is almost certain.
Haseeb A. Drabu is an economist, and writes on monetary and macroeconomic matters from the perspective of policy and practice. Comments are welcome at email@example.com
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