Opinion: Don’t push the RBI to slacken its own paradigm
The RBI gives complete flexibility to banks to determine the process and contours of the restructuring plan
The Reserve Bank of India (RBI) is under tremendous pressure to dilute its policy announced on 12 February. This was the famous circular that contained a new paradigm for banks on how to deal with stressed assets and restructure them. It contains the much derided inflexible 180-day rule, after which a non-restructured loan is automatically referred to the bankruptcy process. Along with releasing the new paradigm, the RBI also closed down all the other earlier schemes, such as corporate debt restructuring (CDR), strategic debt restructuring (SDR) and the Scheme for Sustainable Structuring of Stressed Assets (S4A).
The new paradigm is a clean and transparent approach necessitated for several reasons. First, now that the country has a coherent, time-bound bankruptcy process enshrined in a law, the Insolvency and Bankruptcy Code (IBC), there is no need for the RBI to separately specify restructuring schemes for stressed loans.
Second, under the earlier approach, banks went to great lengths to avoid downgrading a loan even after a default. This was to avoid having to provision for stressed assets, which escalated further when the stressed asset became a non-performing asset (NPA). Thus the success of CDR, SDR and S4A in the actual restructuring of stressed loans was very limited or zero. There were complications because of the problems of collective decision making, and opportunities for arbitrage. It seemed as if banks did not really care about loan recovery, but only wanted to avoid having to provision, as it affected their profitability. This delay also helped the borrower avoid the defaulter or NPA tag. There was, thus, a convergence of interests between the lender and borrower. This was referred to as the borrower-lender nexus by the RBI governor in his speech of March 2018. No wonder this led to the culture of extend and pretend, and “kicking the can down the road”. It was only after an asset quality review forced on the banking system in 2014 that the full extent of NPAs was revealed and ratios started mounting. Until then the stressed assets, despite defaults, had avoided the NPA tag through various machinations. Now that the IBC is in place, there is no need for such forbearance from the regulator.
The third reason for the new paradigm is that as regulator, the RBI really has no role in specifying restructuring mechanisms. It was forced to do so in the absence of the IBC. This is strictly a commercial matter between borrower and lender. The RBI can only specify timelines for the two to work together and restructure and bring the loan back to health. The new paradigm says that the loan has to be restructured (with fresh equity infusion, or partial sale of equity for debt) and with a plan, in such a way that the residual debt is of investment grade, as endorsed by a rating agency. For this, the RBI has given a generous time limit of 180 days. The clock starts after the first day of default. On the 91st day, the account becomes an NPA. However, if even after 180 days the restructuring plan is not in place, the case automatically triggers the insolvency process and is referred to the National Company Law Tribunal.
The RBI paradigm is thus outcome-oriented and does not specify any process parameters at all, unlike earlier schemes. Indeed it gives complete flexibility to banks to determine the process and contours of the restructuring plan. In particular, gone are the constraints of getting majority consensus in a joint lender forum, or any uniformity in approach in the case of multi-lender resolution plans.
The RBI will simply not budge from its 180-day time limit. In the case of a corporate bond, even a one-day default leads to a downgrade. But in the case of loans, is it not strange that several months and years can go by without any downgrade in asset quality?
It is this credit culture of the past that the RBI is trying to change, and bring some discipline to. It also brings sanctity to the debt contract. This discipline has huge positive externalities, as funds locked in NPAs become available to new and more dynamic entrepreneurs hungry for fresh credit. Otherwise, banks play with provisioning and under-reporting, keep toxic assets on their balance sheets and avoid haircuts. The debt contract was getting treatment worse than equity. This had to be rectified and can happen only if the new paradigm is stuck to scrupulously.
The Independent Power Producers Association has taken the RBI to court, asking for forbearance on its 180-day rule. If the RBI starts making sector-specific exceptions, who is to say that another sector will not make a similar demand? There is a huge moral hazard in acceding to the demands of the power sector. It is true that the potential NPAs in the power sector could be as large as ₹1.8 trillion, which are yet to be acknowledged. But a sectoral carve-out from a clean and transparent RBI paradigm risks undermining the big effort in inculcating a healthy credit culture and discipline. The power sector’s problems need exclusive fiscal treatment, along with sectoral reforms in pricing, governance, fuel-supply assurance and logistics optimization of fuel movement.
Putting the onus on the RBI to take care of power sector woes will cause damage to the larger agenda of building a credible reputation for a paradigm that is clean and enhances the desired credit culture. The courts and the government are well advised to steer clear of pushing RBI on this. Diluting its paradigm will also hurt the IBC, which is one of the government’s strongest structural reforms.
Ajit Ranade is an economist and a senior fellow at the Takshashila Institution, an independent centre for research and education in public policy.
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