The cornerstone of the latest change in NPA (non-performing asset) recognition and resolution is the Insolvency and Bankruptcy Code (IBC). Every stressed loan where banks either fail to implement a resolution plan, or fail to stick to the deadline of implementing one, will find its way into the courts.
Which are these loans?
Indian banks are sitting on a restructured loan pile of close to Rs1.6 trillion even after the steady slippage of these accounts into the NPA category over the last several quarters.
The bulk of these are feared to be on their way to the bankruptcy courts, according to analysts.
On top of this are the loans that are overdue beyond 60 days called special mention accounts (SMA-2), which are roughly 3.3% of total loans of the banking system.
Starting 1 March, the total stressed loan pile of close to Rs10 trillion will need the implementation of a resolution plan within 180 days, failing which the account must go to the National Company Law Tribunal.
That means post-1 September, many borrowers could find themselves in the clutches of IBC.
Until then, 40 big borrowers who account for close to Rs3.7 trillion of NPAs either admitted under IBC or on way to getting admitted will keep banks busy with the tribunals. These are from the two lists the Reserve Bank of India (RBI) drew for banks for quick resolutions using IBC. It is clear that bankers will find themselves pacing the court corridors for the better part of fiscal year 2019 (FY19).
Recall that the comments that emerged from the management of big Indian banks after the December quarter results was that the worst is over in terms of bad loan recognition. Most of them saw FY19 as a year of better performance. In the light of the fresh bad loan rules and their implications, we are a long way from saying the worst is over for the lenders.
Banks’ provisioning requirements are unlikely to slow down even in the first half of FY19, some analysts reckon. Analysts at Crisil Ltd expect the bad loan cycle to peak by only March 2019. The fact that the Bank Nifty fell 1.4% and PSU Bank Nifty 4.78% on Wednesday shows that markets have woken up to the damage that could be caused in the short run.
Banks have got nothing but tough love from the regulator. Even the gift of recapitalisation given by their biggest shareholder will now hardly suffice for growth. Now all that lenders can hope is that the courts won’t unceremoniously dump huge haircuts on them. Says a report by Kotak Institutional Equities Research, “Given that the IBC code is still in its infancy, we believe that it would have been useful to see the outcomes of cases, recovery rates under this mechanism and the challenges faced while implementation referred under this code before this emerges as the default process for resolution of loans. Note that the risk of liquidation is extremely high in this process and stringent rules on promoter participation can result in substantially higher provisions than previously estimated."
It is very likely that, given these difficulties, banks will be far more cautious while granting corporate loans. Instead, they will continue to court retail customers, perhaps with even more vigour now.
Analysts at Jefferies believe that these rules could alter risk-taking by banks and “stymie capital flow in to productive sectors especially infrastructure segment, where projects are hampered not just owing to financial conditions but face a multitude of political, execution and environmental risks".
The Kotak note points out that liquidation risks will rise across the board during an economic slowdown.
While the RBI move will be good for the banking system in the long run, it will entail a substantial cost.