Getting the banks to turn on the lending tap

Most of the solutions in the air today will take time to take effect, when it is urgent to revive credit growth now


Photo: iStock
Photo: iStock

An Indira Gandhi Institute of Development Research (IGIDR)-Brescon workshop on banks’ stressed assets brought together banks, companies, analysts, regulators and academics. The different perspectives enabled the discussion to arrive at solution-subsets acceptable to all parties.

Stressed assets in India are not large compared to other countries, and are concentrated in a few firms and banks. Core asset sales should be feasible. But the problem has been allowed to fester since 2011. Low growth and high interest rates have compounded the value of debt in the absence of revenue—high growth and low interest rates have been most effective in bringing debt down through world history. The share of chronically stressed assets with interest cover of less than 1 has reached 33.5% for companies. The problem is urgent since credit growth has fallen to a historic low of less than 10%. Only retail and short-term credit show growth. Private investment is also stagnant. Growth cannot revive under these conditions. Even so, participants agreed short-run turnaround remedies exist to prepare banks to fund a new investment cycle.

Countries such as the US, which quickly infused capital in troubled banks, saw the fastest return to health compared to Europe, where problems were allowed to fester. Cooperation between regulators, banks and companies drove India’s own recovery from stressed assets in the early 2000s. Fear of legal action under hostile takeovers is currently delaying restructuring.

Most of the solutions in the air today will take time to take effect, when it is urgent to revive credit growth now. It is useful, therefore, to divide suggestions into long- and short-run.

Developing a vibrant ecosystem, including a corporate bond market, a culture of risk management, easy exit through the bankruptcy code, asset reconstruction companies with deep pockets, and regulated credible intermediaries to evaluate assets and provide quotes to buyers and sellers are all necessary but cannot happen overnight.

The government is reluctant to infuse the funds necessary to clean the balance sheets of public sector banks (PSBs). There are budgetary constraints, but also concerns about poor governance and moral hazard. But the latter is due to systemic aspects that can be changed. Even if public ownership is reduced, PSBs need healthy balance sheets to raise money on good terms from markets. Allowing insurance companies to invest in additional tier-I bonds of banks is one way to help meet capital adequacy requirements.

India has yet to solve the problem of providing risk capital for industrialization. Initially, the public sector made losses, then the development banks failed, and now commercial banks are in trouble. Why should the taxpayer have to pick up the tab every time? The general principle is that risk should be allotted to those most able to bear and best able to alleviate it. While tax-backed governments may be able to bear risk better than an individual firm, the latter is best positioned to take actions that moderate risk and therefore must have significant equity at stake. The required ecosystem of venture funds, long-term finance institutions and instruments will take time to come up. There was a plea to revive development financial institutions to finance infrastructure and core industries, either setting up new institutions or strengthening existing ones, adequately revamped and supported by low-cost, long-term funds.

Turning to the short-run, if capital infusion was likely to be staggered, the idea that banks could be allowed to amortize provisions over a period of three to five years in step with the planned recapitalization of their balance sheets, together with reforms that improve incentives for honest commercial decisions, was acceptable to all.

Under transparent non-performing assets (NPA) recognition and adequate staggered provisions, interest accrual which increases debt and stressed assets can be stopped. Adequate provisions are necessary to withstand analyst scrutiny, and allow debt to be sold at fair market value, permitting sustainable restructuring of borrower balance sheet. They can be consistent with the new accounting standards IND-AS, to be adopted in 2018, under which carrying loans at fair value will become mandatory, and provisions will rise.

While the aim of regulatory action was to get banks to restart lending to viable business, in practice NPAs carry considerable stigma. They encourage cosmetic rather than viable loans, constrain borrowers in fund-raising, and hurt their business prospects. NPAs on account of first-time debt restructuring could be renamed and classified as a subset of standard assets with full disclosure. Provisioning could be higher than for standard assets but lower than for substandard.

If a firm is recapitalized so there is no impairment in the value of debt, or if the terms and security structures of the new loans are superior, making expected loss zero, the asset classification of new loans could be maintained as standard.

There were many ideas to impart more flexibility to and reduce delays in current restructuring schemes and legal processes. For example, the 5/25 scheme could be applied to the sustainable debt portion of the Scheme for Sustainable Structuring of Stressed Assets (S4A) Scheme.

While broader governance reforms improve PSB accountability, distorted incentive systems leading to inaction need to be corrected. The amendment to the Prevention of Corruption Act could be introduced in the winter session. In parallel, the Oversight Committee and bank settlement commissions, which protect individual decision-takers, could be stabilized and their scope expanded. The distinction between corrupt and erroneous decisions has to be made. Reducing the government’s bank shareholding to below 50% would immediately rescue banks from audit and questioning by parties with a limited understanding of banking and of commercial decisions.

Corporates in the group wanted legacy problems due to external shocks addressed for those with a sustainable business plan and substantial own financial and emotional equity at stake. They pointed to the highway sector where such a pragmatic approach was delivering results. But easy exit and a right to fail are equally necessary.

Ashima Goyal and Nirmal Gangwal are, respectively, professor at IGIDR and founder of Brescon Advisors.

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