A new year, a new central bank governor. Yet the first salvo to come out of the Reserve Bank of India’s (RBI) policy arsenal in 2019 is encouragement of good old “extend and pretend" lending.
Banks and shadow banks are being allowed a one-time restructuring of loans of up to ₹ 25 crore to micro, small and medium enterprises (MSMEs) that were in default on 1 January, without having to mark them as non-performing assets (NPAs), RBI said on Tuesday. Lenders are being given an extension of 15 months (up to 31 March 2020) to pretend that these stressed loans are standard. All they have to do is to make additional 5% loss provisions. By contrast, a secured loan classified as non-performing attracts immediate provisioning of 15%, rising progressively to 40%—even 100%—as recovery became increasingly doubtful.
What’s disturbing here is the U-turn in the RBI’s philosophy.
Classifying restructured loans as non-performing is a standard prudential requirement. India relaxed the norm in 2001 to encourage banks to clean up an overhang of corporate debt that had piled up in the exuberant first decade of the country’s economic liberalization. The solution back then lay in encouraging lenders to send problem loans to so-called corporate debt restructuring (CDR) an out-of-of-court mechanism that helped banks recover some money in the absence of a modern bankruptcy law. Lenders could keep loans referred to the CDR as standard on the books, meaning they didn’t have to make steep provisions for losses.
However, the temporary palliative became a perennial crutch. When dealing with the aftermath of a different credit cycle in May 2013, it became clear to RBI that banks were using the restructuring fig leaf to hide bad loans. To end the abuse, RBI said it would scrap the asset-classification forbearance by 1 April 2015.
Even before that day arrived, there was enormous lobbying by banks at the behest of powerful corporate borrowers. India then was ranked 136th in the world for resolving insolvency; a modern bankruptcy law was still more than a year away. So RBI governor Raghuram Rajan relented and gave lenders new tools—Strategic Debt Restructuring (SDR) and (a year later) Scheme for Sustainable Structuring of Stressed Assets, or S4A—to avoid making provisions.
It wasn’t a free lunch. Rajan also began an asset quality review in 2015, forcing banks to step up disclosure of bad debt. The stick annoyed errant debtors more than the restructuring carrot pleased them. Rajan had to leave after just a single three-year term. But his successor Urjit Patel continued to tighten the screws. Now that there finally was a functioning bankruptcy law, Patel scrapped all the halfway houses—CDR, SDR and S4A—in February last year. Relaxed norms for asset classification and loan-loss provisioning also went away.
That shock therapy made corporate lobbyists more livid. Facing an all-round assault on the central bank’s capacity for independent action, Patel abruptly left last month before completing his tenure. The new RBI governor Shaktikanta Das has begun his term by bringing back forbearance in a small but significant way. It’s small because India’s ₹ 101 trillion credit market is overwhelmingly skewed toward large borrowers. Non-farm business loans of less than ₹ 25 crore account for only 22% of the pie; remove individual borrowers, and the share shrinks to 13%.
Yet it’s a significant step politically. MSME loans have been under elevated stress since Prime Minister Narendra Modi’s disastrous demonetisation move in November 2016, a policy blunder followed up by a goods and services tax (GST) that raised compliance costs for a large number of tiny firms.
The non-performing asset (NPA) ratio for the larger of the MSME borrowers—ticket size between ₹ 10 crore and ₹ 25 crore —was 14.5% in June, up from 12.8% two years ago.
The banks don’t want this pile to grow any further. That much is obvious. It’s also clear that the Modi government wants to ease the tax compliance burden on small businesses ahead of 2019 Lok Sabha elections. However, it’s not the job of the banking regulator to join the government as sentiment booster.
N.S. Vishwanathan, an RBI deputy governor, said last April that “shorn of all forbearances", India’s new regulatory framework for stressed assets was finally on par with international norms, and that giving up on it would amount to “letting go waste" India’s landmark bankruptcy regulation.
That’s the risk now. Small business owners—as well as distressed farmers—have clout only before elections; billionaires wield their power indefinitely. Getting politicians to promise farm loan waivers and “MSME loan in 59 minutes" is easy. But now that RBI has started flip-flopping, it’ll become that much easier for the tycoons to rewind the credit culture—back to the debtor-friendly show it always was.
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Andy Mukherjee is a Bloomberg Opinion columnist covering industrial companies and financial services. He previously was a columnist for Reuters Breakingviews. He has also worked for the Straits Times, ET NOW and Bloomberg News.