Home >Industry >Banking >Treat wilful defaulters as freeloaders: RBI’s Rajan

Mumbai: Reserve Bank of India (RBI) governor Raghuram Rajan had stern words for companies who have wilfully defaulted on loans to banks, saying that such borrowers should be seen as freeloaders rather than being celebrated as captains of industry.

Rajan also indicated that regulatory forbearance given to restructured loans will end as per schedule starting April 2015.

“We need a change in mindset, where the wilful or non-cooperative defaulter is not lionized as a captain of industry, but justly chastised as a freeloader on the hardworking people of this country," Rajan said while speaking at the Institute of Rural Management, Anand (IRMA) in Gujarat.

This is not the first time Rajan has come out strongly against corporate borrowers who are seen to have the ability to repay dues to the banking system but have failed to do so.

Under RBI norms issued in July 2012, a wilful default is said to have happened when either a borrower has not paid the bank even if he is in the capacity to repay, when the funds sanctioned by the bank have been diverted by the borrower for other purposes, when the borrower has siphoned off funds sanctioned by the bank or when the borrower, without the knowledge of the lender, has disposed of the property or moveable assets which were pledged for availing the loan.

“Promoters do not have a divine right to stay in charge regardless of how badly they mismanage an enterprise, nor do they have the right to use the banking system to recapitalize failed ventures," Rajan had told reporters on his first day of taking charge in September 2013.

Since then, the banking regulator has been taking steps to tighten norms for such defaulters. For instance in September, RBI had said banks will be able to take action against guarantors to such defaulters.

RBI has also been in talks with capital market regulator, the Securities and Exchange Board of India (Sebi), to see if wilful defaulters can be barred from accessing the capital markets. Under current norms, once a borrower is termed a wilful defaulter, he cannot access further bank financing but can still access the capital markets. While Sebi discussed the matter at its board meet earlier this month, a decision is yet to be taken.

“Perhaps the reason we have been so willing to protect the borrower against the creditor is that the hated moneylender looms large in our collective psyche. But the large borrower today is not a helpless illiterate peasant and the lender today is typically not the sahukar but the public sector bank. In other words, we are the lender," said Rajan in his speech on Tuesday, adding that when the large promoter defaults wilfully, he is essentially robbing the taxpayer and making it costlier to fund new investment in the economy.

The focus on the issue of wilful defaulters has sharpened after companies such as Kingfisher Airlines Ltd were served such notices by banks, including United Bank of India, in September this year. Kingfisher Airlines owes 7,000 crore to various banks.

Rajan also called for timely and fair application of current laws and new institutions like “bankruptcy courts and turn-around agents" to prevent wilful defaults.

He, however, added the solution is not “more draconian laws" which could be circumvented by large borrowers and likely hurt small ones, but more timely and fair application of current laws.

No forbearance

Separately, Rajan indicated RBI is not in favour of extending regulatory forebearance for restructured accounts, even while signalling that some relief could be provided in restructuring rules.

Effective 1 April, RBI’s regulatory forbearance, under which banks were allowed to qualify restructured assets as standard, will come to an end.

For now, banks are setting aside 5% of the value of the loan to cover the risk of default on any restructured asset. Starting next fiscal, when all restructured assets will be termed as non-performing assets (NPAs), or bad loans, the requirement will increase to a minimum 15%.

The change will also mean banks’ bad-loan portfolio will swell. In fact, fearing an increase in bad assets once change takes effect, bankers have already started asking RBI to extend the forbearance for another year, the Business Standard reported on 15 October. The bankers, according to the report, have told RBI if the window is not extended, their gross NPA ratio will rise to 10% from 4% in March 2014.

Commenting on requests to extend forebearance, Rajan said such requests were short sighted.

“This is short-sighted, especially on part of banks. Today, the market does not distinguish much between non-performing loans and restructured loans, preferring to call them both stressed loans and discounting bank value accordingly. Mutilating Shakespeare, an NPA by any other name smells as bad!" he said.

He added that forbearance makes bank balance sheets opaque. Bad loans in the banking system rose to 4.03% of total advances in 2013-14 from 3.42% in 2012-13 and 2.94% in 2011-12, finance minister Arun Jaitley told the Parliament on 1 August, as slower economic growth and delays in securing statutory approvals such as environmental clearances and completing land acquisition stalled many big-ticket projects, hurting companies’ ability to generate cash flows and repay loans on time. The economy grew less than 5% in each of the previous two years.

“The fundamental lesson of every situation of banking stress in recent years across the world is to recognize and flag the problem loans quickly and deal with them. So regulatory forbearance, which is a euphemism for regulators collaborating with banks to hide problems and push them into the future, is a bad idea," Rajan noted.

However, the RBI governor hinted at some relief in restructuring norms for banks, saying some of the requests for greater flexibility to restructure loans are legitimate.

Bankers have been seeking flexibility to restructure loans to align them with the project’s cash flows, and for the ability to take equity so as to get some upside in distressed projects, said Rajan.

“These are more legitimate requests as they imply a desire to deal more effectively with distress. The regulator has been reluctant to afford banks this flexibility in the past because it has been misused by bank management. Nevertheless, recognizing that it cannot micromanage the resolution of distress, RBI is exploring ways to allow banks more flexibility in restructuring. This is a risk we are prepared to take if it allows more projects to be set on the track to recovery," he said.

V.P. Shetty, former chairman at IDBI Bank Ltd and currently executive chairman at JM Financial Asset Reconstruction Co. Ltd, said institutions like debt recovery tribunals need competent and efficient people who can settle cases in a fixed time-frame.

“One reason why defaults are happening is because some defaulters have gained confidence because of postponements in recovery hearings. Now the government is thinking about a bankruptcy law, which is a good move. Unless the legal system is strengthened and implementation of law made simpler and straightforward, defaults will not be curtailed," Shetty said.

Daljeet Singh Kohli, head of research at India Nivesh Securities Ltd, said discontinuation of regulatory forebearance is the right thing to do but RBI should ensure banks implement the new rules.

“No forebearance could mean bad loans could increase in the short term but this short-term pain will be beneficial for the sector in the long term. Bankers are always wanting to delay the recognition of bad loans and for this to change RBI has to ensure changes are mandatory for everyone," he said.

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