Light At The End Of The Tunnel

The New Year brings hope for lenders in India that a powerful regime will soon be in place for speedy and meaningful resolution of impaired or insolvent assets, following the government's intention to implement the Bankruptcy and Insolvency Code.

While bankers do see it as a step forward, there is also scepticism about the pace at which cases will be dealt with. The fruitless experience with the SARFAESI Act (Securitisation and Reconstruction of Financial Assets and Enforcement of Security Interest Act 2002) and the tardy pace of work at legal forums like Debt Recovery Tribunals (DRT) reflects the perception of stakeholders.

The proposed Bankruptcy Code is expected to consolidate existing laws relating to insolvency and bankruptcy into a single legislation. More importantly, it aims to expedite the insolvency resolution process to 180 days, which in certain circumstances could be fast-tracked to 90 days or extended by 90 days. The process of insolvency, liquidation and bankruptcy through the National Company Law Tribunal (NCLT) and DRTs will also come under its ambit.

Even assuming a quick nod from the Lok Sabha for the Bill to come into force early in 2016-17, it may be a while before the benefits begin to accrue. While the economy seems to be on the mend, there are hardly any signs of improvement in the asset quality of banks, which have been reeling under non-performing loans for over three years. If anything, the outlook remains negative.

Before delving into where things stand now and the steps being taken to address the concerns, it is worthwhile to understand how things have come to such a pass.

Light at the end of the tunnel
The credit boom in the 2003-2008 period, often dubbed as the golden years for the Indian financial sector, made bankers believe that steady growth was possible indefinitely.

While banks were basking in the 'high' of credit expansion, the global financial crisis hit the world in 2007-08. The collapse of US-based investment bank Lehman Brothers in September 2008 changed the game, leading to a freeze on liquidity across the world. Shocks began to be felt throughout the system, often reaching shores like India, which believed it was immune from global currents. The Indian banking system was no exception. Global exposures of Indian banks suffered a severe blow.

Sensing the severity of the crisis, the Indian government and the financial regulator swung into action to protect the system and provided stimulus for growth. Commercial banks fashioned schemes to push credit demand from retail and small and medium-sized enterprises. In tandem, the Reserve Bank of India (RBI) came up with a plan for restructuring loans of viable units facing a temporary liquidity crunch. That helped these units tide over the rough phase.

Light at the end of the tunnel
Perhaps, the seeds of the current problems facing Indian banks were sown in this period, as corporate restructuring was done in a hasty and half-baked manner. There followed the long domestic slowdown after 2011, often blamed on policy paralysis and a demand slump. Its expanse was wide and deep, with the infrastructure sector facing the brunt.

And as is often the case, the fate of the Indian economy soon began to be reflected in the books of banks. Payment delays and defaults snowballed into a larger challenge. The most recent assessment about where things stand now, and a peek into the days ahead, comes from the Financial Stability Report (FSR) released by RBI in December 2015. The report suggests that the risks to the banking sector have increased since June 2015, mainly owing to deteriorating asset quality and sluggish profitability. Gross non-performing assets (GNPAs) of commercial banks were up at 5.1 per cent in September 2015, from 4.6 per cent in March 2015.

The restructured standard advances as a percentage of gross advances declined to 6.2 per cent from 6.4 per cent, but the stressed advances ratio (GNPA plus restructured advances) increased to 11.3 per cent, from 11.1 per cent during the same period. At present, there are little or no signs of any reduction in stress. If anything, it may only rise in the coming quarters.

The Financial Stability Unit of RBI that authored the FSR conducted stress tests on banks' books found that under the base case scenario, the GNPA ratio of commercial banks may rise to 5.4 per cent by September 2016. Subsequently, the situation could improve, with this ratio moving down to 5.2 per cent by March 2017.

However, if economic conditions weaken, things could worsen for banks. Under severe stress conditions, the GNPA ratio could increase to 6.9 per cent by March 2017. However, banks would still be in a position to withstand pressures. Their risk-adjusted capital adequacy at system as well as bank-group level would remain above nine per cent, indicating resilience, the report says.

The stress is seen across sectors and borrowers. But it is concentrated in specific sectors and among large companies. The five sub-sectors - mining, iron & steel, textiles, infrastructure and aviation, with 24.2 per cent share in the total advances in June 2015 - contributed 53 per cent of the total stressed advances, according to the FSR. Similarly, large borrowers' share of GNPAs stood at 87.4 per cent in September 2015, compared to 78.2 per cent in March 2015.

"One of the possible inferences could be that banks extended disproportionately high levels of credit to corporate entities/promoters who had much less 'skin in the game' during the boom period," the report said.

RBI Governor Raghuram Rajan flagged the threat to banks from weakening corporate performance and debt-servicing capabilities of leveraged business groups. "Corporate sector vulnerabilities and the impact of their weak balance sheets on the financial system need closer monitoring," Rajan said.

The good news is that the RBI has set a target of cleaning up bank balance sheets by March 2017, and is already moving in this direction, with Rajan having held discussions with the chief executives of banks in mid-December on the issue.

With many initiatives like the 5/25 scheme and strategic debt restructuring in place to tackle stressed assets, bankers believe the governor's goal, though tough, is reasonable. The aim of the 5/25 scheme is to help companies in the infrastructure and core sector to tide over bad times, allowing them repayment over longer periods in sync with the status of their projects.

Also, the effect of efforts made over the last few years - such as close monitoring of credit quality and rules for early recognition and early resolution - would begin to show results, a top executive of a public sector bank said. The government has also taken sector-specific measures in identified infrastructure and core sectors where there is stress due to systemic issues. A case in point is the UDAY (Ujwal Discom Assurance Yojana) scheme for distribution companies in the power sector.

State governments, which own power distribution companies (or discoms), are expected to take over 75 per cent of discoms' debt over a period of two years - 50 per cent in 2015-16 and 25 per cent in 2016-17. Broking firm CLSA points out that collectively, discoms owe banks Rs 5.5 lakh crore. Thus, UDAY will alleviate some of the pressure on the exposure of loans.

The proposed Bankruptcy Code will further strengthen the system, going forward, experts said. Hopefully, a recovery in the economy will lift some boats, as stressed units begin to perform and resume repayment.


  • Restrictions on extra facilities to defaulters
  • Commencing criminal action against defaulting borrowers
  • Removal of directors of companies from boards
  • In extreme cases, change in management.

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