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Beleaguered banks: Resolving the NPA issue

  With the Banking Regulations Act being amended to form the Banking Regulations (Amendment) Bill 2017, it is to be hoped that the problem of stressed assets will be addressed to a large extent. Both the banks and the RBI have initiated proceedings against defaulters.  

Dr Suresh Srinivasan

Stressed assets have become a recent phenomenon, and are proving to be a major challenge to the banking industry. These are an aggregation of Non Performing Assets (NPA) and restructured loans. NPA signifies the loans on which borrowers have failed to repay the interest of the principal within 90 days of the due date of such payment. The magnitude of stressed assets also has a bearing on the national competitiveness, as it impacts the strength of the overall banking system.

Addressing NPAs

A weak banking system that carries higher than acceptable levels of NPAs is a critical problem for the economy, the Reserve Bank of India and, of course, the banks. There have been a number of initiatives in the recent past to resolve the NPA issue and strengthen the banking system. Examples of these are Strategic Debt Restructuring (SDR) and Scheme for Sustainable Structuring of Stressed Assets, also called S4A. However, while these have been initiated, they haven’t really led to tangible success in terms of material reduction in NPA levels.

The S4A scheme

For instance, the S4A scheme allows a bank to convert a part of the debt of the defaulting company into equity and bring in capable investors. These investors can take over the management of the company and turn it around from bankruptcy. In such a scenario, the loans would also be bifurcated into sustainable and non-sustainable parts, so that the latter is converted to equity. The sustainable part would be left as is, where present cash flows would be able to service such debt, under the new management.

Naturally, the banks will have to take on losses that result from writing off a part of the loan. However, the overall debt becomes better secured under the management of a more responsible shareholder.

Recently, in addition to these initiatives, an amendment to the Banking Regulations Act 1949 has brought in the new Banking Regulations (Amendment) Bill 2017. This enactment is more aggressive and puts more power in the hands of the Central government and the RBI and the banks. The Centre has the authority to direct the RBI, through the banks to act against loan defaulters. The National Company Law Tribunal (NCLT) will then initiate proceedings under Insolvency and Bankruptcy Code, 2016.

The expected end result is a hastening of the process of debt collection from defaulters, and a consequent reduction in NPA levels of banks.

The problem

Stressed assets are pegged at close to `10 lakh crore. This translates to more than 15% of the total loans and advances, while it is pegged at around 5% for the private banks. A large part of these stressed assets are not provided for. More importantly, it is being assessed that the quantum of stressed assets has surpassed the net worth of banks, which is a major concern.

Out of the total stressed assets, around `7 lakh crore are NPAs. On the one hand, the Basel III norms require the banks to become more capitalised, while on the other hand, the stressed assets are wiping out significant levels of capital. Although the problem is primarily a major concern for the public sector state owned banks, private banks like ICICI and Axis too are showing stress of late. As far as sectors are concerned, the stressed assets are primarily spread across infrastructure and construction, commodities including iron and steel, power, telecom and real estate.

The proposed solution

A panel within the RBI has been constituted, and it will identify defaulting companies. The respective banks will then initiate insolvency proceedings against these companies.

As a first stage towards addressing the NPA and strengthening the banking system, the RBI’s 5-member oversight committee panel has identified 12 defaulters that jointly account for 25% of the total NPA, in value. The RBI has given directives to the banks to initiate insolvency proceedings against these 12 companies and more.

It is being reported that in fact, a total of 500 companies have already been identified, and the proceedings against the remaining 488 will commence soon. Banks too have been informed of this list, and have been asked to initiate a resolution plan within the next 6 months.

Recent developments

As the first step, the State Bank of India, which is the lending bank, has already referred three companies — Bhushan Steel, Essar Steel and Electrosteel Steel — to the NCLT to initiate insolvency proceedings. These three companies alone account for around 10% of the overall stressed assets.

The Essar Steel case

Essar Steel, for example, has around `45,000 crore of debt for a couple of years. The NCLT has now appointed independent resolution professionals; these individuals will now work with the companies to come up with a resolution to repay the outstanding loan within 6 months. It has been reported that at least 30% of the debt may be surmised to be unsustainable. Hence, this may have to be converted into equity, diluting the majority shareholders, the Ruias. However, these are still early days and the plan needs to progress, crossing many hurdles, before a resolution is arrived at.

Waters have already become murky. It is interesting to note that when the RBI referred Essar Steek to the NCTL for the initiation of insolvency proceedings, Essar Steel filed an application with the Gujarat High Court challenging the proceedings. Essar alleged that its selection by the RBI was arbitrary, and that the central bank had discriminated against it; Essar has claimed that other companies had been granted six months for a restructuring plan and resolution. Although the high court immediately stayed the proceedings, it later dismissed Essar’s application. Naturally, such delay tactics are highly probable, and could slow down the process.

RBI involvement to help banks

Banks themselves find it very challenging to bring up the issue of some of the defaulters, as they purportedly fear investigations. They have possibly hesitated to take the required action in time on this very basis, but this amendment brings in the RBI’s mandate and support to initiate action, relieving the banks of the responsibility. This is perceived as the weakness of the banks, and such an amendment will thus help the banks to move forward on a much better footing to address the NPA issue. This is a very positive result of the amendment.

Moreover, the banks get a comfort factor, apart from the RBI backing, since even if they have to compromise with the lenders, it is in the best interests of reducing the NPA. However, on the flip side, it is also possible that banks may take the RBI’s intervention for granted, and thereby dilute the quality of future lending. If so, this can be prove to be damaging.

On balance, these are extremely positive developments, and they should go a long way in strengthening India’s institutional base and address one of the most crucial issues challenging the country’s banking system.