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NPA ordinance: The last act of bad loan resolution?

LiveMint logoLiveMint 14-05-2017 Tamal Bandyopadhyay

Former Reserve Bank of India (RBI) deputy governor Subir Gokarn once said banks’ NPAs (non-performing assets) are like cancer; if not treated at an early stage, the patient will die.

Viral Acharya, RBI’s current deputy governor in charge of monetary policy, has used another simile to illustrate the same point—a bank not keeping adequate capital to absorb losses arising out of bad loans is like allowing a person who has slipped off the terrace of a skyscraper to fall and die.

The latest move of empowering RBI to directly intervene in the resolution process is expected to speed up the exercise, but some of the banks will “slip off the terrace of a skyscraper and die” unless the government keeps the parachute ready in the form of fresh capital infusion. Of course, the banks can generate some capital by revaluing their fixed assets innovatively, but that will not be enough to keep them alive.

For quite some time, RBI has been tightening the noose around those banks which are refusing to see the writing on the wall. Apart from a series of resolution schemes to clean up the bad assets, in the five months between August and December 2015, the banking regulator conducted a first-of-its-kind asset quality review and asked them to set aside money for three kinds of loans: NPAs that they had not recognized yet; loans given to projects where the dates of commencement of commercial operations had passed but the projects had failed to take off; and, restructured loans.

The banks had to provide for the first two types of loans in two phases in the December and March quarters of fiscal year 2016, at least 50% each. For restructured loans, they were asked to make 15% provision in six quarters, 2.5% each, till March 2017. As and when all banks announce their March quarter earnings, clarity will emerge on the enormity of the bad loan problem.

Meanwhile, the RBI has done three things in the run-up to the banks’ March quarter earnings. It has revised and tightened more-than-a-decade old prompt corrective action or PCA structure; encouraged banks to make provisions at higher rates for the advances given to the stressed sectors of Indian economy; and asked banks to make suitable disclosures in case there are any material divergences in banks’ asset classification and provisioning to that of the RBI norm in the ‘Notes to Accounts’ of their upcoming annual financial statements.

Are these enough? Definitely not and this is why the Banking Regulation Act has been amended through an ordinance and the RBI has been given more powers to direct banks and speed up the process, since without a healthy banking system, the economy cannot run at full throttle.

In 2004, the PCA norms had stipulated that if a bank’s net NPAs crossed 10% but less than 15%, there would be special drive to reduce NPAs; the loan policy would be reviewed and steps would be taken to strengthen credit appraisal skills, among other things. For net NPAs 15% and above, in addition to these, banks’ boards would be called for discussion on a corrective plan of action.

The latest PCA framework talks about three risk thresholds for net NPAs—6% to less than 9%, 9% to less than 12%, and 12% and above. Apart from the bad assets, capital, return on assets and the leverage ratios are other benchmarks for a bank’s health-check. Depending on the scale of deterioration in a bank’s health, the RBI can take actions, varying between a clamp-down on branch expansion to higher provisions, removal of the management and even superseding the board.

Tightening of the PCA norms has been long overdue. Between 2001 and 2005, the average net NPAs of the banking system were 4.2%, less than now. Besides, since the reserve requirements such as cash reserve ratio (part of deposits kept with the RBI) and the statutory liquidity ratio (mandatory bond buying) were far higher then, in absolute terms, banks’ bad assets were much lower. Indian Overseas Bank, United Bank of India and Dhanlaxmi Bank Ltd, and IDBI Bank Ltd have already come under the ambit of the PCA; once the March quarter earnings are out, a few more banks could come under it. In the December quarter, at least 11 banks had more than 9% net NPAs, including three State Bank of India associates which have since been merged with it.

The banks have also been asked to make higher provisions for standard advances given to the stressed sectors of the economy, following a board-approved policy which must be reviewed every quarter. The RBI is particularly worried about the telecom sector—which is undergoing severe stress—and has asked banks to review the segment latest by 30 June and consider making higher provisions for standard assets in this sector. Under current rules, most standard assets attract a provision of 0.4%. The few exceptions include credit to commercial real estate (1% provision) and residential real estate (0.75%).

However, the regulator hasn’t specified the extent of higher provisioning for standard loans to the telecom and other stressed sectors. Leaving it to the discretion of individual bank boards, the regulator may see different levels of provisioning for the same sector by different banks. After all, their risk management system is not uniform and that’s why some banks have more NPAs than others.

Indeed, the telecom sector is stressed. The Indian banking sector’s exposure to the telcos is around Rs1 trillion and the industry’s overall indebtedness is close to Rs5 trillion. Besides, the telcos need to pay around Rs3 trillion to the government for sharing revenue on the allocation of spectrum. The rating agencies have been downgrading the outlook of many telcos. Intense competition is denting their revenue and the so-called interest coverage ratio—calculated by dividing a company’s earnings before interest and taxes (Ebit) by its interest expenses—for the sector has dropped below 1. Interest coverage ratio of 1.5 or lower questions a company’s ability to meet interest expenses. Aggregate revenue of the telecom sector was Rs1.8 trillion in 2016 against an overall liability of Rs8 trillion.

The power segment is probably in an equally bad if not worse shape. There are coal-based projects worth 15,200 megawatt (MW) which have been completed, but do not have the power purchase agreements (PPAs) and hence are not eligible for fuel-supply agreements. The cost of imported coal hits their profitability. Another set of coal-based power projects—for 13,700MW—have been at various stages of construction. Indeed, captive coal blocks bring down the cost of operations but deprecation in currency (these power plants were planned in 2010-11 when rupee-dollar exchange rate was 44/45 vs. 64/65 now) and time overrun have made them unviable.

Besides, there are stranded gas-based power plants to produce 15,000MW and hydro power for 2,000MW.

The UDAY Scheme (Ujwal Discom Assurance Yojna) announced in November 2015 by the central government for the stressed electricity distribution companies (discoms) envisaged taking over 75% of the debt of the discoms by Indian states. The plan has been to bring down the interest cost and push up the revenue by raising the tariff. However, there seems to be no light at the end of the tunnel for the power plants. Indeed, they have saved on interest costs but many discoms are facing regulatory hurdles for increasing the tariff and the aggregate technical and commercial losses have risen.

The engineering, procurement and construction segment where over Rs1 trillion bank loans have been stuck is also not showing any signs of improvement. In August 2016, the Cabinet Committee on Economic Affairs, headed by Prime Minister Narendra Modi, approved a series of initiatives to revive the construction sector.

The National Institution for Transforming Indiam or NITI Aayog, quickly followed that up to address the delayed payment or non-payment by the government departments and public sector undertakings after completion of projects. Typically, all these projects are fraught with disputes which delay payments. It was decided that 75% of the payments to the contractors must be released against bank guarantees where the arbitration awards have gone in their favour but are being challenged. The payment will flow into an escrow account and the lenders’ dues will be cleared on priority. However, no progress is seen as yet.

The only segment which is seeing substantial improvement is steel where banks’ exposure is to the tune of around Rs3.3 trillion. Steel companies’ earnings or Ebit has doubled following the anti-dumping measure by the government in the shape of a minimum import price, coupled with availability of raw material following regular auctions by iron ore miners. The government’s decision to prefer domestically manufactured iron and steel products will also help the steel producers even as the demand is set to rise for various upcoming projects of Indian Railways, the dedicated freight corridor, regional airports, smart cities, and the mushrooming of affordable housing projects, among others.

Simply put, it is unfair to blame the bankers alone for the current mess. We need to sensitize the bankers on risk management and monitoring of projects as much as we need to address the core issues in real economy to avoid the nightmare of certain banks being buried under the pile of bad loans. The steps taken by the steel ministry to revive the sector can be emulated by others. For instance, many of the old power plants of NTPC Ltd have served their lives and they need to be decommissioned. It will take a while for the new plants to come up and their tariff will be relatively higher. NTPC Vidyut Vyapar Nigam Ltd, NTPC’s trading arm, can buy from the 15,200MW power projects that do not have PPAs. The blended cost—the cost of power purchased from these plants and NTPC’s new generation plants—will be less and bring down the cost for the discoms.

This is second of a two-part series on bad loan resolution. The first part can be read here.

Tamal Bandyopadhyay, consulting editor at Mint, is adviser to Bandhan Bank. He is also the author of A Bank for the Buck, Sahara: The Untold Story and Bandhan: The Making of a Bank.

His Twitter handle is @tamalbandyo

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