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Tuesday, July 10

UPSC: Non Performing Asset – Problem & Solutions


Video Part 1: https://www.youtube.com/watch?v=bkbD9Jvx9XE&t=1s

Video Part 2: https://www.youtube.com/watch?v=EK1JhUo5jGo&t=6s

Miles to go for the new bankruptcy code

22.05.18 TH EDITORIAL

Good news has finally started to roll out of the refurbished bankruptcy courts. Tata Steel acquired 73% stake in the bankrupt firm Bhushan Steel for about ₹35,000 crore last week, making it the first major resolution of a bankruptcy case under the new Insolvency and Bankruptcy Code (IBC). Bhushan Steel was one among the 12 major accounts referred to the National Company Law Tribunal at the behest of the Reserve Bank of India last year to ease the burden of bad loans on banks. The proceeds from the acquisition will go towards settling almost two-thirds of the total outstanding liabilities of over ₹56,000 crore that Bhushan Steel owes banks. While it may be unwise to read too much into a single case, the Bhushan Steel resolution is nevertheless an encouraging sign for banks because they typically manage to recover only about 25% of their money from defaulters. In fact, between April 2014 and September 2017, the bad loan recovery rate of public sector banks was as low as 11%, with non-performing assets worth 2.41 lakh crore written off from their books. The Finance Ministry now expects banks to recover more than ₹1 lakh crore from the resolution of the other cases referred by the RBI to the NCLT. If the banks do indeed recover funds of this scale, it would considerably reduce the burden on taxpayers, who would otherwise have to foot the bill for any recapitalisation of banks. Even more important, speedy resolution would free valuable assets to be used for wealth-creation.

The resolution of one high-profile case, however, should not deflect attention from the many challenges still plaguing the bankruptcy resolution process. The IBC, as the government itself has admitted, remains a work in progress. This is a welcome piece of legislation to the extent that it subsumes a plethora of laws that confused creditors; instead it now offers a more streamlined way to deal with troubled assets. But issues such as the proposed eligibility criteria for bidders have left it bogged down and suppressed its capacity to help out creditors efficiently. Also, the strict time limit for the resolution process as mandated by the IBC is an area that has drawn much attention, and it merits further review in order to balance the twin objectives of speedy resolution and maximising recovery for the lenders. To its credit, the government has been willing to hear out suggestions. It would do well to implement the recommendations of the Insolvency Law Committee which, among other things, has vouched for relaxed bidder eligibility criteria. Going forward, amendments to the bankruptcy code should primarily be driven by the goal of maximising the sale price of stressed assets. This requires a robust market for stressed assets that is free from all kinds of entry barriers.

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Cleaning up balance sheets

14.06.18 TH

What is a ‘bad bank’?

WILL TAKE ON ALL BAD LOANS AND TRY TO SALVAGE SOME VALUE FROM THEM: The Central government has revived the idea of setting up an asset reconstruction or asset management company, a sort of ‘bad bank’ first mooted by Chief Economic Adviser Arvind Subramanian in January 2017. Mr. Subramanian had envisaged a Public Sector Asset Rehabilitation Agency that would take on public sector banks’ chronic bad loans and focus on their resolution and the extraction of any residual value from the underlying asset.

AFTER GETTING AN INDIRECT BAILOUT, PSB CAN FOCUS ON FRESH LENDING: This would allow government-owned banks to focus on their core operations of providing credit for fresh investments and economic activity. Unlike a private asset reconstruction company, a government-owned bad bank would be more likely to purchase loans that have no salvage value from public sector banks. It would thus work as an indirect bailout of these banks by the government.

How will it be capitalised?

3 POSSIBLE FINANCIERS OF BAD BANK: GOVT, RBI, PRIVATE SECTOR – NOT SURE HOW FINANCING WILL BE DONE: The bad bank will require significant capital to purchase stressed loan accounts from public sector banks. The size of gross NPAs on the books of public sector banks is currently over Rs. 10 lakh crore. The chances of private participation are low unless investors are allowed a major say in the governance of the new entity. Private asset reconstruction companies have been operating in the country for a while now, but have met with little success in resolving stressed loans. The CEA had proposed a significant part of the bad bank funding to come from the Reserve Bank of India, which is likely to be a tricky proposition. That means the government, which is already committed to recapitalising state-run banks, will have to be the single largest contributor of capital even if private investors are roped in.

How will it help the NPA problem?

WILL HELP BANKS IN RE-STARTING THE LENDING PROCESS: Hiving off stressed loan accounts to a bad bank would free public sector bank balance sheets from their deleterious impact and improve their financial position. As the quality of a bank’s assets deteriorates, its capital position (assets minus liabilities) is weakened, increasing the chances of insolvency. Some analysts believe that many public sector banks are effectively insolvent due to their poor asset quality. Consequently, banks have turned risk-averse and credit growth has taken a hit. If managed well, a bad bank can clean up bank balance sheets and get them to start lending again to businesses.

BAD BANK WILL NOT SOLVE THE CORPORATE GOVERNANCE CHALLENGES AT PSB: But it will not address the more serious corporate governance issues plaguing public sector banks that led to the NPA problem in the first place.

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Reality check

28.06.18 TH EDIT

RBI report warns that the worst on NPAs may be yet to come. Urgent changes are needed

GNPA OF SCB CAN RISE FURTHER TILL 2019: The worst is far from over for Indian banks. The financial stability report released by the Reserve Bank of India on Tuesday has warned that the gross non-performing assets (GNPAs) of scheduled commercial banks in the country could rise from 11.6% in March 2018 to 12.2% in March 2019, which would be the highest level of bad debt in almost two decades.

GNPA OF PCA BANKS CAN BE EXPECTED TO INCREASE MORE THAN OTHERS: This puts at rest the hope of a bottoming out of the NPA crisis that has affected the banking system and impeded credit growth in the economy. The GNPA of banks under the prompt corrective action framework, in particular, is expected to rise to 22.3% in March 2019, from 21% this March.

INCREASED PROVISIONING FOR LOSSES + WEAKENED CAPITAL POSITION: The RBI believes that this will increase the size of provisioning for losses and affect the capital position of banks. In fact, the capital to risk-weighted assets ratio of the banking system as a whole is expected to drop from 13.5% in March 2018 to 12.8% in March 2019.

EXTERNAL ECONOMIC HEADWINDS = US FED IR TIGHTENING + INCREASE IN COMMODITY PRICES: The deteriorating health of banks is in contrast to the economy, which is on the path to recovery, clocking a healthy growth rate of 7.7% during the last quarter. The RBI, however, has warned about the rising external risks that pose a significant threat to the economy and to the banks. The tightening of monetary policy by the United States Federal Reserve and increased borrowing by the U.S. government have already caused credit to flow out of emerging markets such as India. The increase in commodity prices is another risk on the horizon that could pose a significant threat to the rupee and the country’s fiscal and current account deficits. All these factors could well combine to increase the risk of an economic slowdown and exert pressure on the entire banking system.

A major highlight of the financial stability report is the central bank’s finding that public sector banks (PSBs) are far more prone to fraud than their private sector counterparts. This is significant in light of the huge scam unearthed at a Punjab National Bank branch earlier this year. The RBI notes that more than 85% of frauds could be linked to PSBs, even though their share of overall credit is only about 65%. This should come as no surprise given the serious corporate governance issues faced by public sector banks, which to a large extent also contributed to the lax lending practices that are at the core of the NPA crisis.

URGENT NEED FOR REFORMS TO IMPROVE FINANCIAL PERFORMANCE AND DECREASE OPERATIONAL RISKS: In his foreword to the report, RBI Deputy Governor Viral Acharya has noted that governance reforms at PSBs, if implemented, can help improve their financial performance and also reduce their operational risks. For now, the RBI expects the government’s recapitalisation plan for banks and the implementation of the Insolvency and Bankruptcy Code to improve the capital position of banks. These reforms can definitely help. But unless the government can gather the courage to make drastic changes to aspects of operational autonomy and the ownership of PSBs, future crises will be hard to prevent.

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Risky recourse

02.07.18 TH EDIT

LIC GETS PERMISSION FROM IRDA TO BUY 51% STAKE IN IDBI: The Insurance Regulatory and Development Authority of India has approved a proposal to allow the Life Insurance Corporation of India to increase its stake in the ailing state-owned IDBI Bank to 51%.

NPA PROBLEM AT IDBI LED IT TO BE PLACED UNDER PCA IN 2017: The plan envisages the insurer injecting much- needed capital into the financially stressed lender, which was placed under the Reserve Bank of India’s prompt corrective action framework in May 2017 as a consequence of its non-performing assets rising beyond a threshold.

While there are no details on how exactly this capital infusion will take place — reports suggesting that the LIC may acquire the additional 40% stake it would need to reach 51% shareholding from the Government of India — market speculation and media reports have estimated figures north of Rs. 10,000 crore.

While for the LIC the sum is a small fraction of the Rs. 1.24 lakh crore it received in just first-year premiums in the year ended March 31, 2017, for IDBI Bank the funds would almost equal the Rs. 12,865 crore in capital infusion it got from the government in the last fiscal.

Whether this will be adequate to even staunch the flow of red ink at the troubled bank, leave alone help it turn around, is another matter. The bank posted a net loss of Rs. 8,238 crore in the 12 months ended March 31, 2018, and is facing the prospect of more losses with gross non-performing assets rising to 28%.

WITH LIC INFUSING CAPITAL, GOVT’S FISCAL DEFICIT IS UNHARMED; BUT IS THIS THE BEST LONG TERM SOLUTION? The proposal raises several troubling questions. The government clearly sees it as a relatively painless way to recapitalise the bleeding bank without adversely impacting its fiscal position, but the risks in increasingly banking on state-controlled cash-rich corporations to help bail out other state-owned companies or lenders are too significant to be glossed over.

BY GIVING LIC PERMISSION TO BREACH 15% EXPOSURE LIMIT IN A COMPANY, IS IRDA NEGLECTING INETRESTS OF POLICYHOLDERS? Then, there are the regulators. The IRDA, whose mission is to “protect the interest of and secure fair treatment to policyholders”, is reported to have exempted the LIC from the well-reasoned 15% cap on the extent of equity holding an insurer can have in a single company. This puts at risk the interests of the premium-paying customers of the LIC.

SEBI IS ALSO TWEAKING ITS OWN RULES TO ALLOW THESE KIND OF TAKEOVERS: The Securities and Exchange Board of India has in the past waived the mandatory open offer requirement under its takeover regulations when it involved a state-run acquirer and another state enterprise as the target. As the capital markets watchdog, SEBI has an obligation in all such cases to weigh the interests of the small investor.

SHOULD RBI PERMIT THESE INTERCONNECTIONS AND RISK THE HEALTH OF LARGER PARTS OF FINANCIAL SYSTEM? And the RBI, as the banking regulator, should not ignore the contagion risks that the level of “interconnectedness” the proposed transaction would expose the entire financial system to.

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