Myriad solutions for bad loans: A snapshot

• HDFC securities
• 09 Aug 2018
• Knowledge Centre

The notable spike in bad loans has drawn the central bank’s attention – yet again - to the provisions, the banking sector has made against these accounts.
In Feb-18, the central bank tightened rules related to bank loan defaults with an aim to push an increased number of defaulters towards bankruptcy courts. It has also done away with a number of existing loan-restructuring mechanisms to accelerate the process.

 

Under the scanner

 

According to the Reserve Bank of India (RBI), the new system will force lenders to identify and tackle any stressed asset accounts faster. Under the new rules, lenders should classify a loan as a non-performing asset (NPA) immediately upon restructuring. For loans larger than Rs 2,000 crore, the resolution plan needs to be completed within 180 days, or else the account must be referred to the Insolvency and Bankruptcy Code.

 

It warned that “Any failure of banks to meet the said timelines or any attempt they take to hide the actual status of accounts or evergreen stressed accounts will expose them to potential monetary penalties and other actions.”

 

Rules pertaining to resolution plans were also tightened. According to the RBI, “any such process involving restructuring or change in ownership for large accounts with loans of Rs 100crore or more will need independent credit evaluation by credit rating agencies authorized by the RBI.”

The RBI sent a list of 240 accounts to state-owned banks with the directive to classify them as NPAs, in the event that this was not already done.

 

A relook

 

The RBI order came in the wake of the start of the second round of asset quality review (AQR), a methodology initiated by former RBI Governor Raghuram Rajan in FY16. In a speech delivered during that time, Governor Rajan said, “We need to deal with legacy issues that hold back growth and bring changes to enhance the efficacy of our business processes and conduct. The stress in the banking sector, which mirrors the stress in the corporate sector, has to be dealt with in order to revive credit growth.”

 

The magnitude of the problem started becoming clear at this juncture, as banks were forced to acknowledge bad loans in their books. Mr. Rajan’s successor Mr. Urjit Patel, the present RBI Governor, continued to pressurize the banking sector until it was forced to recognize all the bad loans in its books and make provisions for them. Any discrepancy between the bank's own estimate of bad loans and the RBI's view also needs to be reported now.

 

In a recent development, Finance Minister Mr. Piyush Goyal stated that the Government has accepted a report submitted by a committee of bankers led by Punjab National Bank Chairman Mr. Sunil Mehta. Herein state-run banks could set up an asset management company (AMC) for the resolution of loans above Rs 500 crore. They will also set up alternate investment funds to raise money and support this AMC. The Sunil Mehta Committee on bad loans resolution recommended a five-pronged strategy – Project 'Sashakt' – to deal with non-performing assets in the country's banking system. This strategy includes:

 

• SME resolution approach,
• Bank-led resolution approach,
• AMC/AIF-led resolution approach,
• NCLT/IBC approach, and 
• An asset-trading platform.

 

The magnitude of this problem cannot be undermined, as its toxicity spills over and harms the country’s economy.