Over the next few weeks, expect many banks in India to report weak
results. That won’t be just because of the lingering pain of the economic
slowdown of the last couple of years and the inability of many companies or
borrowers to repay some of their borrowings. The poor numbers for lenders will be due more to the progressive
tightening of rules on dealing with bad loans. The exercise of cleaning up
bank balance sheets, which started in 2015, and a signal by the Reserve Bank of
India to put an end to forbearance — or the easing of rules — will now mean a
longer wait for better results.
The latest trigger
Historically, the approach to dealing with bad
loans (where either the principal or interest or both of a loan is due
after 90 days) in India has been relatively lenient — to allow banks time
to set aside funds to provide for potential losses on such loans, and greater
leeway to lenders to negotiate with borrowers. There has been a reluctance to
address the issue head-on because of pressure from influential borrowers —
especially large corporates — and resistance from the government, which owns a
large number of banks, and even the banks themselves. Tighter rules would mean
stumping up more cash, lower profits, and restrictions on the ability to lend
more.
With the new insolvency law
coming into force in 2016, and growing outrage against instances of corporate
fraud, promoter-driven firms leaving banks bleeding, and banking supervisors
who have been criticised for the pile of bad loans, this regulatory forbearance may now be coming
to an end.
In February, the RBI did away with several schemes such as strategic debt restructuring, which allowed banks
to grant extra time to borrowers to repay. Next, rules were tightened to classify a loan as ‘bad’ or a ‘Non-Performing
Asset’ (NPA) if the borrower failed to repay by even a day or two —
triggering worries among borrowers, banks, and the government. But the
regulator appears to be standing firm — RBI Deputy Governor N S Vishwanathan
said last week that the sanctity of the
debt contract needed to be restored. When a company raises money through
bonds from the market and then defaults, its rating is downgraded, the yields
on the bonds rise, its cost of financing goes up, and investors file suits,
Vishwanathan said — no such reaction was, however, seen in case of bank
borrowings.
Cleaning up vs growth
It is argued that this approach would cramp lending by banks at a time
when most indicators show that growth is on the upswing. The government and
the RBI discussed this in 2015-16 as well. In 2016, a few months before his
term ended, RBI
Governor Raghuram Rajan said, “In sum, (on) the question of what comes first, clean up or growth, I think the answer is
unambiguously clean up.” That was the lesson from every other country that
had faced financial stress, Rajan had said then.
This is the approach that Rajan’s
successor Urjit Patel has adopted. Another central banker, Viral Acharya, too,
has acknowledged the mistakes that RBI has made in this regard earlier. At an
event last year, Acharya said: “Unfortunately
for a variety of reasons, RBI has engaged in various forbearance schemes saying
you can take another 18 months or two years (on bad loans).” In one way or
the other, he had said, RBI had actually contributed to the NPA problem
becoming more acute over time. At the end of December 2017, bad loans had
reached Rs 8.87 lakh crore, and were expected to rise even higher by the end of
March 2018.
The lessons elsewhere
A tougher environment governing lending by banks may lead to tensions
between the regulator and the owner of banks, which in India is overwhelmingly
the government. Some of that is already visible — but the positive spin-off has been behavioural
changes on the part of borrowers, specially of companies whose promoters
fear the loss of control, as also of
banks who have to monitor lending far more closely. Since the 2008-09
financial crisis, banks in the West, too, have been subject to far rigorous
standards and changes of rules, and have been
forced to set aside funds in their balance sheets for expected losses in the
future — complete with an expected-loss model, a strategy for tackling
non-performing loans (NPL), dedicated NPL units, early warning engines, etc.
India first announced the adoption of global rules on setting aside
capital for bad loans in 1992, at the peak of the balance of payments crisis.
Yet, it was almost 2003 before those early rules were implemented. In
between, every time the issue of enforcing tighter rules came up, it was argued
that since there was no crisis, there was no need to carry out disruptive
changes — and that India, with a dominant state-owned banking system with an
implicit guarantee of the sovereign, did not need to be rigid. In the brief
periods during which rules on bad loans were tightened, they were a reflection
more of political will — shown, for example, by the Prime Minister and Finance
Minister of the day a few years ago.
The choice this time
For policymakers, it is a difficult
choice to make. It requires political stamina to endure longer timeframes to
clean up bank balance sheets and a return to robust lending to firms and
households. Experience has shown that regulation often lags risk-taking by
banks. Policymakers in India will have
to decide whether the difficult choice they have to make will lead to a “cliff-edge effect”, as they call it in the West.
Pulling back could mean a setback to the behavioural changes in promoter
attitudes and accountability that are already under way, besides posing the
risk of more public funds being put to use for bank capital and promoting
financial and overall integrity. All these hinge on governance practices —
not just in the financial sector, but elsewhere, too.
Credit: Indian Express Explained
(http://indianexpress.com/article/explained/the-policy-choices-that-rbis-new-bad-loan-rules-present-5149143/)
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