It is officially curtains down on forbearance and perhaps even restructuring as we know it. Emboldened with the Insolvency and Bankruptcy Code (IBC), the Reserve Bank of India (RBI) has overhauled how banks must recognize stress and provide for bad loans in future.
What do the rules prescribe? The central bank has disbanded all existing special schemes such as S4A (Scheme for Sustainable Structuring of Stressed Assets), strategic debt restructuring and even the much-maligned corporate debt restructuring.
The new set of rules mandate that all future restructuring will amount to the account being termed as bad, which means an immediate provisioning of 15%.
Lenders must report a loan to the centralized database of RBI on default after 30 days. In essence, loans showing incipient signs of stress will be called special mention accounts.
The rules prescribe time-bound steps of recognizing stress, acting on it and failing strict timelines, referring the account to IBC.
But the most important aspect perhaps is the disclosures entwined in the rules. The centralized database has already ensured there is full disclosure of a borrower to all lenders irrespective of whether they have an exposure or not. Given the spotlight on the borrower, the probability of collusion between lenders and borrower is minimal. RBI has also ensured that the bigger the borrower, the stricter are the norms and timelines for banks.
Banks must report defaults on a weekly basis for borrowers having more than Rs5 crore in bank loans.
What impact does all this have on banks?
At the outset, this means a further hit to profits for the banks because strict timelines could mean larger referrals to IBC, according to some analysts. Given that the stress in the economy is still there, probability of larger haircuts or even liquidation in some cases could increase. Provisions too will rise.
It is quite likely that bank stocks could see a knee-jerk decline as the crutches of various restructuring schemes are now off. Banks that are predominantly corporate lenders could see their valuations take a further hit.
Nevertheless, since asymmetric information across banks was behind the colossal rise in the pile of stressed assets to about Rs10 trillion, the long-run benefits of a clean balance sheet cannot be ignored.
The central bank, on its part, will continue to look over banks’ shoulders through supervisory reviews. RBI has warned that it would penalize banks if it found in such reviews that they have been hiding dirt like before.
Banks have paid dearly after they disclosed the dirty loans they had continued to sweep under the carpet, under the guise of restructuring. A look at the erosion of value of public sector banks is proof enough. Even as investors flay banks for their hand-in-glove actions of the past with regards to loans, RBI must own up to its contribution by way of rules that made it easier to hide bad loans.
Perhaps this is the best form of apology from RBI—mending past mistakes by removing opaque rules and letting in the sunshine. It is disappointing that it took a Rs10 trillion mountain of bad loans for RBI to pull the fig leaf off.