RBI to have far-reaching powers to resolve NPA of banks…

The Ordinance to amend the Banking Regulations Act 1949, which was cleared by the Cabinet on 03^rd May obtained presidential asset on May 05^th. With the approval of the Ordinance, the Banking Regulations Ac t virtually confers unlimited powers on the Reserve Bank of India (RBI) to deal with NPAs. While the fine print of the completed ordinance is still awaited; and that will give a lot more clarity, the broad contours are already out…

Key highlights of the NPA Resolution Ordinance…

• The total stressed assets in the banking system had already crossed the Rs.10 trillion marks. In fact, the Asset Quality Review (AQR) introduced by the RBI in 2015 had forced a lot of banks to make more realistic classification of accounts and also provide for losses more realistically. This had forced many PSU banks and a few private sector banks to take a fairly large hit on the bad assets front.

• Most of the stress in the banking sector comes from sectors like Steel, Infrastructure, EPC and textiles. In fact, the RBI has already highlighted the telecom sector as another sector where the levels of stress are rising quite rapidly, with EBIT struggling to even cover regular payments. This is the background in which the NPA Resolution ordinance was approved by the president.

• One of the key underlying themes of the ordinance is that it virtually gives sweeping powers to the RBI on all aspects of NPA resolution. With the passage of the ordinance, the RBI gets full powers to intervene to identify an NPA account, push for a settlement, constitute a committee to decide on the haircut on the asset value and also advise the banks to initiate insolvency proceedings against the borrower under the Insolvency and Bankruptcy Act 2016.

• The RBI will now issue a new framework for the resolution of distressed assets. The most important aspect of this ordinance is that the RBI will outline a time-bound resolution process. Firstly, there will be an attempt at negotiation. Secondly, the RBI will constitute a committee that will agree upon and implement a haircut at which the case can be amicably resolved or hived off to an Asset Reconstruction Company (ARC). Thirdly, if these measures do not seem to be yielding adequate results, then the RBI can even ask the banks to initiate insolvency proceedings against the bank.

• The idea here is that the RBI will have a virtual Carte Blanche, to intervene and demand action on all aspects of managing and negotiating bad assets. The most important part of this ordinance is that every step to NPA resolution will be time-bound. Currently, there are highly stressed groups like the Jaypee Group, Bhushan Group, Alok Textiles Group and the Lanco Group which have been pulling on their cases due to the open-ended legal framework in place. By making the entire process time-bound, the RBI will instil a sense of discipline in the banks and the borrowers to arrive at a resolution at the earliest.

• The RBI will rely on sector-specific expert committees for the purpose. These expert committees will assist the RBI in assessing the options before the banks, giving a SWOT analysis of the various methods employed to reach a settlement, negotiate the process, assess the realizable value of assets in a scientific and realistic manner etc. This sector-specific approach will not only enable the RBI to advise the banks more fruitfully but also in dealing with the borrowers more meaningfully.

What does this ordinance mean for banks?

From the bank’s perspective there will be quite a few positives. In fact, the cabinet estimates that at least half of the problem cases pertaining to stressed assets will be resolved in the next 1 year. Of course, the RBI only needs to focus on the top-50 stressed accounts and the problem will be predominantly taken care of. The big advantage of this Ordinance is that it provides an institutional framework. Today, any decision on negotiation with borrowers or offering haircuts or even selling to ARCs is the decision of individuals. This is a major bottleneck as bankers are wary that any decision taken, despite the best intentions, may backfire and result in subsequent investigations by the ED and Vigilance departments. This has forced many bankers to play it safe and let the problem fester. By providing an institutional mechanism, the problem of the unwillingness of individual bankers to take the risk is largely obviated. To that extent this will be positive for the stressed banks as it will provide an early resolution to the stressed asset problem and also facilitate unlocking of billions of dollars that are stuck up in such stressed assets.

But, there is the risk of moral hazard in this ordinance…

Some senior banking analysts have pointed out that there is the risk of moral hazard in allowing banks to outsource the more difficult decisions to the RBI. It will create a moral hazard because prudent bankers may not be too inclined to worry about the recovery aspect as there is anyways an institutional mechanism to take care of that. This may either force banks to get overly aggressive on lending targets or become less prudent in lending practices.

Finally, the big challenge in the entire dispute resolution will be finding buyers. It is one thing to find buyers when there is that odd asset up for sale. But it will be a different problem altogether when there is a glut of assets available for sale. That could depress prices and add further to the stress on bank balance sheets. Despite these innate challenges, the ordinance is a good starting point for resolving the burgeoning crisis of stressed assets. While the fine print is still awaited, the good news is that a start has been made in the right direction!