Home / Industry / RBI kicks off reform process to curb bad loans

Mumbai: The Reserve Bank of India (RBI) on Tuesday suggested an array of measures to address the growing pile of bad loans in the banking system, calling for early recognition and resolution of sticky assets, stricter action against wilful defaulters, and more freedom for asset reconstruction companies in handling non-performing assets (NPAs) of banks.

The measures, outlined in a discussion paper, include early formation of a lenders’ committee to work out plans for resolution of stressed loans, better regulatory treatment of such loans for banks that act quickly on the resolution of bad assets, and the independent evaluation of large loan restructuring cases.

RBI is worried about the growing size of bad loans in India’s 81 trillion banking sector. About 2 trillion of these loans are bad and at least 4 trillion are being restructured. Together, that constitutes about 10% of all bank loans.

Indian banks, especially the state-owned ones, have traditionally been loath to seize management control from truant borrowers, but that is what Rajan suggested in the October interview and it is reflected in the discussion paper.

The paper also suggests ways to discourage banks from lending to habitual defaulters.

“We have to first recognize the problem and solve it. If you delay dealing with it, the problems will magnify," a central banker said at an informal briefing ahead of release of the discussion paper.

The apex bank has sought comment from the public on the discussion paper in the next fortnight, after which final guidelines will be issued.

Going by the discussion paper, banks need to create special categories of loan accounts, depending on the extent of stress. The discussion paper also proposes steps to enable better functioning of asset reconstruction companies and encourages private equity funds to play an active role in the stressed assets market.

RBI’s intention is to make banks recognize warning signs of weakness in a loan account early and mandatorily form a joint lenders’ forum (JLF), or a formal group of lenders, and formulate a corrective action plan if an account is turning bad.

In cases of loans with an existing consortium of lenders, the consortium will serve as a JLF, while, in other cases, banks with highest exposure will convene a JLF and facilitate exchange of credit information of the account, RBI said.

The formation of such forums is mandatory for distressed corporate borrowers, engaged in any type of activity, with aggregate fund-based and non-fund-based exposure of 100 crore and above, though banks can form them even in those cases where exposure is less than 100 crore.

If the principal or interest payment is overdue by between 61 days and 90 days, the lenders’ forum can form a corrective action plan for the stressed account either by obtaining a specific commitment from the borrower to regularize the account or by restructuring the loan. If the process fails, lenders can initiate the recovery process, RBI said.

RBI will set up a central repository of information on large credits (CRILC) which will collect, store and disseminate credit data to lenders. Banks will have to furnish information to CRILC on all borrowers having aggregate fund-based and non-fund-based exposure of 5 crore and above.

Besides commercial banks, bigger non-banking finance companies (NBFCs) too will have to furnish information, RBI said. That apart, banks will have to furnish details of all current accounts with outstanding balance of 1 crore and above.

The RBI discussion paper proposes to tighten the rules for loans recasts. For loans above 500 crore, an independent committee of experts will evaluate the proposal before the loan is restructured under the so-called corporate debt restructuring (CDR) channel.

The panel, which will look into the viability aspects of the proposal, is required to give recommendations on these aspects to the CDR cell within 30 days, the paper said.

Further, during restructuring, banks can also consider transferring promoters’ holdings to a security trustee or an escrow arrangement till the turnaround of the company, enabling a change in management control, if they wish it, RBI said.

On a cumulative basis, banks have restructured 2.7 trillion worth of bank loans under the CDR mechanism as of September.

CDR is a forum of lenders where banks typically offer a payment holiday to a financially stressed company, extend the period in which the loan has to be repaid, cut the cost of borrowing and, sometimes, even reduce the amount of debt the borrower has to pay back.

If banks implement quicker restructuring packages under the JLF frame work, the apex bank will offer them special asset classification benefits on restructured loans. At the same time, if banks try to conceal the actual status of the accounts by sanctioning additional facilities without genuine reasons, RBI will impose accelerated provisioning.

For instance, for secured sub-standard assets, where the account has been classified a non-performing asset for between six months and a year, RBI will impose a provision of 30% of loans, instead of 15% as of now. If the asset is not secured, provisioning is proposed to be as high as 50% against 20-25% now.

Noting that banks are facing asset-liability mismatches or funding long-gestation projects with short-term deposits, RBI said it may allow financial institutions to take over infrastructure and other project loans from existing lenders.

Such institutions can fix a repayment period by taking into account the life cycle and cash flows from the project. “In such cases, even if the revised repayment period is longer than the residual repayment period in the earlier bank’s books, the account will not be considered as restructured, as long as a proper due diligence has been done by the refinancing bank/institution," RBI said.

Experts welcomed the central bank’s move. “This is a step in the right direction. But there is a lot to be done," said Abizer Diwanji, a partner and head of financial services at audit and consulting firm EY, formerly known as Ernst and Young.

For instance, the discussion paper doesn’t address the issue of existing stock of bad loans in the banking system and ways to recover these.

Under current norms, banks need to set aside a provision of 5% of the total loan amount for all new restructured loans, while the provisioning shoots up to 15-20% if these loans turn bad. For standard assets, the existing provisioning is 0.4%.

“All efforts to improve the quality of assets in the country are welcome as they will strengthen the banking sector," said Saurabh Tripathi, partner and director at Boston Consulting Group.

Tripathi added that systemic issues and policy bottle necks are responsible for a significant portion of the bad loans on the books of banks. “Nevertheless, any systemic improvement (on asset quality management) can make the banking system more robust," he said.

The central bank also proposes stricter action against wilful defaulters. If the name of the company or promoter appears in more than once in the list of wilful defaulters, the provisioning will shoot up to 5% even if the account is standard, RBI said. If the account turns bad, the provisoning will be much higher. Besides, no additional loan facility will be given to such companies by any banks.

That apart, banks can also classify companies as non-cooperative borrowers, if the company is “being unreasonable" to the bank and doesn’t furnish information, RBI said.

The central bank has also warned banks from depending on credit appraisal reports prepared by outside consultants, especially the in-house consultants of the borrowers. Instead, they should carry out their independent and objective credit appraisal in all cases, RBI said, adding that banks can also engage auditors to ensure that a company is not diverting funds.

To enable asset reconstruction companies (ARCs) operate in a more efficient manner, RBI has proposed changes in the rules governing them. In order to encourage liquidity and price discovery of stressed assets, sale of assets between such companies may be permitted and the issue will be taken up with the government, the central bank said. Besides, the central bank will also consider allowing ARCs to raise limited debt funds to rehabilitate units.

More importantly, private equity firms and large NBFCs with proven expertise in resolution and recovery of bad assets may be allowed to participate in auctions through explicit regulatory affirmation, RBI said.

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