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Illustration: Jayachandran/Mint
Illustration: Jayachandran/Mint

Why regulatory forbearance must end

RBI must clamp down on the routine restructuring of stressed assets

If kicking the can down the road were a competitive sport, India’s state-owned banks would be Olympic champions. After failing to check the rising proportion of bad assets on their books, chiefs of government-owned banks are now lobbying to extend the window of regulatory forbearance that allows them to maintain low provisions against impaired assets. Several indebted companies have joined the chorus to extend the window of regulatory forbearance, and the finance ministry seems to be lending them a sympathetic ear, according to news reports.

There are several reasons why the Reserve Bank of India (RBI) must dismiss such pleas and bring the era of regulatory forbearance to an end. Regulatory forbearance has hid the true extent of vulnerabilities in the banking system and exposed it to a funding shock. The option to restructure assets was meant to be used sparingly but has been heavily abused over the past few years, especially by government-owned banks. The decision to restructure a loan was supposed to be a technical one, taking into account the viability of the borrower. But in case of government banks, the decision to restructure has often been influenced by political considerations, and has depended on the clout of the concerned promoters. As a result, restructured assets of these banks now account for more than twice the size of officially recognized non-performing assets. Restructuring may be a useful tool to tide over tough economic conditions globally but nowhere in the world does this become the default or the permanent mechanism to deal with stressed assets.

The relaxed norms for restructuring assets were introduced during 2008, at the height of the global credit crunch. At that time, the move made good sense since many companies which faced a short-term funding shock could recuperate and start paying back loans, if they were given a breather. Relaxed norms for restructured assets meant that they were classified as standard rather than non-performing assets and did not require the kind of provisioning that bad loans attract. This minimized the sacrifice promoters had to make; it also minimized the hit on banks’ profitability. Promoters of several companies in cahoots with bankers have abused the system since then to ensure that they suffer very little even while their projects turned unviable.

The central bank realized the perverse incentives the regime of regulatory forbearance was generating, and an RBI working group led by B. Mahapatra recommended in 2012 that this regime must end. It pointed out that total restructured assets had outgrown the total non-performing assets and noted that classification of restructured assets as standard was not in line with international best practices. RBI set April 2015 as the deadline for an end to this regime. As the deadline approaches, the clamour for an extension will grow louder.

Extending the window of regulatory forbearance that has allowed such restructuring to flourish may provide short-term succour to banks and corporations but it creates a classic moral hazard problem over the long term. If borrowers know they will not have to suffer for their mistakes, they will keep repeating the mistakes of the past and keep abusing the resources of state-owned banks. Short-term debt relief, whether it be to farmers or to industrialists, undermines the credit culture of an economy and permanently impairs the credibility of banking norms.

We must recognize that we are in the midst of a structural debt problem, and not a short-term funding crisis. The first step to resolving the debt crisis is to recognize the true extent of the problem. An orderly and speedy deleveraging process will ensure that India’s economic recovery is on firm footing. But deleveraging and sale of stressed assets will pick up pace only when promoters of indebted firms and their bankers know that inaction will be costly. As a recent Mint analysis showed, only a few of the large indebted conglomerates have managed to pare debt levels over the past year. The level of loan concentration among the top conglomerates continues to grow.

RBI must blow the whistle now, bring an end to regulatory forbearance, and avoid the temptation of delaying the day of reckoning.

Can a systemic problem of high debts be resolved by restructuring stressed assets? Tell us at views@livemint.com

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