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Stock market reaction to banking regulation ordinance has been positive for banks: report

LiveMint logoLiveMint 24-08-2017 Ami Shah

Mumbai: The stock market reaction to the Banking Regulation (Amendment) Ordinance, 2017 has been positive for banks and their high quality borrowers but negative for distressed firms, suggesting its potential to rejuvenate banking sector health and improve capital allocation across companies, a report released by the Reserve Bank of India on Thursday showed.

The report was authored by Nirupama Kulkarni, Sargam Jain and Khushboo Khandelwal of Centre for Advanced Financial Research and Learning (CAFRAL).

On 5 May, the government issued the ordinance in an effort to accelerate resolution of the Rs9.64 trillion of non-performing assets (NPAs), or bad loans, clogging the Indian banking system.

Under the ordinance, the government may authorise the RBI to issue directions to banks to initiate insolvency proceedings against defaulters under the bankruptcy code, and the central bank on its own accord can issue directions to banks for resolution of stressed assets.

It was mentioned that RBI may form committees with members it can choose to appoint to advise banks on resolution of stressed assets.

The ordinance appears to have been good news for stressed banks as well as high quality borrowers, indicating more scope to improve capital allocation in the Indian economy with significant positive spillover effects for healthy firms and to rejuvenate the banking sector.

These measures, in effect, give the RBI and the central government powers to act directly against any company which has defaulted on its loans.

Cumulative abnormal returns (total extraordinary returns) of stressed banks increased sharply following the finance minister Arun Jaitley’s announcement on 24 April when he hinted at empowering the central bank to address the problem of NPAs in the Indian banking system, said the findings adding that this pattern continues till the event date on 4 May. In contrast, non-stressed banks witnessed a more modest increase in abnormal returns.

Also, abnormal returns between stressed and non-stressed banks widened to almost 5% between the time of finance minister’s announcement and promulgation of the ordinance, indicating markets perceived the ordinance would help the stressed banks in resolving their NPA problem.

Meanwhile, low and intermediate quality firms performed worse than high quality firms in the period.

The second part of the study focusses on the date of the Internal Advisory Committee’s (IAC) first meeting during which defaulter accounts were identified on 12 June, and to look at the immediate impact of the meeting, the analysis is restricted to a shorter period of 6 days.

It was seen that defaulter firms registered a decline in abnormal stock returns compared to the other firms belonging to the same industry as the defaulter firm.

The identification of these firms by the RBI was a clear indication of their poor financial health and it is evident that market lost confidence in these firms during the span of the event window.

In general, the abnormal returns increased for lead banks of defaulter firms and other banks immediately after the event, possibly reflecting that the market perceived that the ordinance will help clean up NPAs from bank balance sheets.

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