D. What steps have been taken to address the problem? To what extent have they been effective?
To cushion the impact on the overall economy, public investment has been stepped up considerably, but this has still not been sufficient to arrest a fall in the overall investment.
The RBI has over the past few years introduced a number of mechanisms to deal with the stressed asset problem. Initially, the schemes focused on rescheduling amortisations to give firms more time to repay. But as it became apparent that the financial position of the stressed firms was deteriorating, the RBI deployed mechanisms to deal with solvency issues, as well. The important mechanisms have been listed below:
1. The 5/25 Refinancing of Infrastructure Scheme:
- Key features of the scheme:
- This scheme offered a larger window for the revival of stressed assets in the infrastructure sectors and eight core industry sectors.
- Under this scheme lenders were allowed to extend amortisation periods to 25 years with interest rates adjusted every 5 years, so as to match the funding period with the long gestation and productive life of these projects.
- The scheme thus aimed to improve the credit profile and liquidity position of borrowers, while allowing banks to treat these loans as standard in their balance sheets, reducing provisioning costs.
- Issues faced: However, with amortisation spread out over a longer period, this arrangement also meant that the companies faced a higher interest burden, which they found difficult to repay, forcing banks to extend additional loans (‘evergreening’). This, in turn, has aggravated the initial problem.
2. Asset Reconstruction Companies (ARC):
- The basic principle of ARCs >>> ARCs acquire NPAs from banks or financial institutions and try to resolve them. They can even infuse more funds in order to reconstruct the asset. If reconstruction is not possible, and the borrower is unwilling to repay the loan, the ARCs even sell the secured assets.
- ARCs are a product of and derive their asset resolution powers from the Securitisation and Reconstruction of Financial Assets and Enforcement of Security Interest Act, 2002 (SARFAESI Act).
- For some time, the RBI has been encouraging the establishment of private Asset Reconstruction Companies (ARCs) so that there can be an efficient division of labour:
- Banks could resume focusing on their traditional deposit-and-loan operations,
- The ARCs could deploy the specialist skills needed to restructure corporate debts.
- Has this strategy worked? >>> Although many ARCs have been created, but they have solved only a small portion of the problem, buying up only about 5 percent of total NPAs from 2014 to 2016.
- Problems being faced >>> ARCs have found it difficult to recover much from the debtors. Thus they have only been able to offer low prices to banks, prices which banks have found it difficult to accept.
3. The Strategic Debt Restructuring (SDR) scheme
- The SDR scheme was introduced in June 2015, under which creditors could take over firms that were unable to pay and sell them to new owners.
- Has the scheme worked? >>> While two dozen firms have entered into negotiations under SDR, only two cases had actually been concluded as of end-December 2016.
4. Asset Quality Review (AQR): The RBI emphasized AQR, to verify that banks were assessing loans in line with RBI loan classification rules. Any deviations from such rules were to be rectified by March 2016.
5. The Scheme for Sustainable Structuring of Stressed Assets (S4A):
- This scheme introduced in June 2016 is the latest measure taken by RBI to tackle stressed assets:
- Under this scheme, subject to certain conditions, RBI has allowed lenders to separate a sustainable part from an unsustainable loan.
- The sustainable debt would be left alone to perform or be restructured if necessary, while the unsustainable debt would be converted into equity or equity-like, long-dated securities and redeemed at a later date.
- Unlike the SDR arrangement, this involves no change in the ownership of the company.
- The idea behind the scheme is that banks would get the upside if the company regains its old glory and it also gives the borrower a second chance to revive the company.
- Has the scheme been successful? >>> Only one small case has been resolved so far under S4A.
In principle, these schemes taken together might have provided a comprehensive framework for dealing with solvency problems. Their success, however, has been limited. Let’s analyse why:
E. Why have the existing schemes not performed satisfactorily?
In part, the problem is simply that the schemes are new, and financial restructuring negotiations inevitably take some time. But the bigger problem is that the key elements needed for resolution are still not firmly in place:
1. Loss recognition: The Asset Quality Review (AQR) was meant to force banks to recognise the true state of their balance sheets. But the banks nonetheless continue to evergreen loans, as the substantial estimates of unrecognised stressed assets make clear.
2. Coordination. The RBI has encouraged creditors to come together in Joint Lenders Forums, but reaching agreement in these Forums has proved difficult because different banks have different degrees of credit exposure, capital cushions, and incentives. For example, banks with relatively large exposures may be much more reluctant to accept losses.
3. Proper incentives. The S4A scheme recognises that large debt reductions will be needed to restore viability in many cases. But public sector bankers are reluctant to grant write-downs because there are no rewards for doing so. To the contrary, there is an inherent threat of punishment, since major write-downs can attract the attention of investigative agencies.
4. Capital. The government has promised under the Indradhanush scheme to infuse Rs 70,000 crores of capital into the public sector banks by 2018-19. But this is far from sufficient.
5. Concentration of stressed assets in a few large over-indebted borrowers:
50 companies account for 71% of the debt owed by IC1 debtors (Companies with earnings not enough to pay the interest obligations on their loans). And the large, over-indebted borrowers are particularly difficult to resolve because of:
- Severe Viability Issues as large write-offs will be required to restore viability to the large IC1 companies.
- Acute coordination failures as large debtors have many creditors, who need to agree on a strategy.
- Serious incentive problems as Public sector bankers are even more cautious in granting debt reductions in major cases, as this may attract the attention of not only the investigative agencies but also the wider public.
- Insufficient capital as debt write-downs in the case of the large debtors could quickly deplete banks’ capital cushions.
While the new Bankruptcy Law could make sense for cases where the write-down needs are particularly large, the problem is that the new bankruptcy system is not yet fully in place, and even when it is, the new procedures (and participants) will need to be tested first on smaller cases. Some considerable time will consequently elapse before the system will be ready to handle the large, complex cases.
F. What now needs to be done?
India has been till date pursuing a decentralized approach, under which individual banks have been taking restructuring decisions, subject to considerable constraint and distorted incentives. Accordingly, they have repeatedly made the choice to delay resolutions.
Perhaps it is time for India to consider adopting a centralized strategy – creating a ‘Public Sector Asset Rehabilitation Agency’ (PARA), charged with working out the largest and most complex cases.
Such an approach could eliminate most of the obstacles currently plaguing loan resolution as:
- It could solve the coordination problem since debts would be centralised in one agency;
- It could be set up with proper incentives by giving it an explicit mandate to maximize recoveries within a defined time period; and
- It would separate the loan resolution process from concerns about bank capital.
For all these reasons, asset rehabilitation agencies have been adopted by many of the countries facing TBS problems, notably the East Asian crisis cases.
How would PARA actually work?
From where would this funding come?
The possible sources of funding could be:
- Government issues of securities.
- The capital markets.
- The RBI.
Major issues that need to be resolved for efficient working of PARA:
1. There needs to be a readiness to confront the losses that have already occurred in the banking system, and accept the political consequences of dealing with the problem. The only defence against the possible charges of favouritism etc. would be to ensure the PARA is thoroughly professional, with plans that maximize – and are seen to maximize – recovery value.
2. The PARA needs to follow commercial rather than political principles.
To achieve this, it would need:
- To be an independent agency, staffed by banking professionals.
- A clear mandate of maximizing recoveries within a specified, reasonably short time period.
3. Pricing: Loans would need to be transferred at the market prices, but establishing the market price of distressed loans is difficult and would prove time-consuming.
Resolving the TBS problem will come at a price, namely accepting and paying for losses. But, this cost is inevitable. Loans have already been made, losses have already occurred and because PSBs are the major sufferers, the bulk of burden will fall on the government. Stressed enterprises will also lose their equity along with management control.
But, the question that remains unanswered is that will it prevent them from making similar mistakes in future? Will it not send a wrong incentive signal to other corporate houses and the better off banks that the government is there to undo your mistakes and clear your mess?