De-stressing the Stressed Assets in Public Sector Banks
[Himani Singh is a legal consultant at YES Bank Limited.]
The Indian banking sector is plagued with high-risk loans, reducing capital flows, over-dependence on debt and, most importantly, increasing stressed assets, more popularly known as non-performing assets (NPAs). In the last one decade, the non-performing assets multiplied manifold, challenging the very roots of the Indian financial sector. Past experiences with restructuring schemes and prudential regulations have had limited success in combating the systemic risks, though several comprehensive financial reforms brought about in the last 2-3 years facilitated the resolution of stressed assets to a great extent.
In this article, I will discuss the recent developments and growth of the Indian banking sector in resolving insolvency. I will specifically highlight the status of public sector banks and their contribution to NPAs in India. In the end, I will attempt to provide a few means for resolution of insolvency in public sector banks and mechanisms that would assist in revitalizing the drained public sector banks going forward.
Recent Reforms and Progress
In 2016, India’s largely troubled bankruptcy regime was revamped and supplanted by a new and radical code – the Insolvency and Bankruptcy Code, 2016 (IBC) – to address the NPA issue. The IBC had been on the anvil for more than a decade and it borrows heavily from experiences in other jurisdictions, both common and civil law systems. Under the IBC, the creditors of the NPAs along with an insolvency professional try to find a viable solution by either restructuring the loan or selling the defaulter’s assets to recover the outstanding amounts. Several other regulations and schemes preceded and followed the introduction of IBC such as Project Sashakt, fast track corporate insolvency process etc.
IBC’s implementation has shown positive results in a short span as India’s rank improved from 136 to 108 in the ‘Resolving Insolvency’ bracket in the Ease of Doing Business rankings released by the World Bank. A Reserve Bank of India (RBI) note based on the unaudited financial statements of scheduled commercial banks up to September 30, 2018 suggests that the worst of the NPA crisis facing India’s banks might be over and that credit growth may also be back.
Status of Public Sector Banks
Despite the overall improving statistics of the NPAs, the public sector banks (PSBs) are still weighing down the consolidated balance sheet of the banking sector. In March 2018, the RBI released a prompt corrective action plan (PCA) to improve the operational efficiency of banks and financial institutions and categorically placed 11 PSBs under the PCA framework. As of January 31, 2019, 3 out of these 11 PSBs have managed to bring down their NPAs below the RBI’s prescribed threshold and are released from the PCA framework. According to the RBI Financial Stability Report, December, 2018, the gross NPA asset ratio may decline from 10.8% in September 2018 to 10.3% in March 2019 and 10.2% in September 2019.
However, the report states that despite projections of recovery, 18 scheduled commercial banks, including all public sector banks still under the PCA framework, may fail to maintain the required capital adequacy ratio, unless capital infusion takes place and banks improve their performance. The balance 8 out of 11 PSBs under the PCA plan are still struggling to improve their capital to risk weighted assets ratio, net non-performing assets and return on assets, NPA recognition and disparity in loan recognition.
It will perhaps take another 5 years or so before the public sector banks and regulatory systems bed down and adjust to this complete overhaul brought in by the IBC and other similar reforms. Perhaps the financial framework itself will modify to cater to the needs of public sector banks; there is constant evidence of this dual mechanism at play. In either scenario, there is a need to bring the troubled banking system in India under a semblance of control. The lingering vulnerability of the internal and external framework governing the public financial sector in India will require a re-balancing and re-examination from a global, complex and interactive perspective.
Re-engineering and the Road Ahead
A combination of governmental measures, joint efforts of market regulators and cooperation of the financial institutions themselves will help leading the recovery process of NPAs in PSBs and in their effective regulation.
Re-capitalization, writing-off and privatization: In October, 2017, the government announced a re-capitalization of scheduled commercial banks to a tune of Rs. 2.11 lakh crores that included budgetary provisions of Rs. 18,139 crores and recapitalization bonds worth of Rs. 1.53 lakh crores. In February, 2019, the government further promised to infuse Rs. 48,239 crores in 12 PSBs to help them improve their financial growth. Between the financial years 2014-15 to 2017-18, an aggregate loan amount of Rs. 32,693 has been written-off by PSBs.
Prior to privatization, it is pertinent that banks are re-capitalized and bad loans are written-off since private players will be unwilling to take over PSBs neck-deep in bad debt. However, considering the socio-political backdrop of India, where most of the social sector programs are routed through PSBs, privatization is not the most viable option. In such a scenario, it is probably time to bring in ‘public-private’ partnerships in the banking sector. A systematic partnership can be devised between the public and the private players, where the proceeds from corporate lending are taken care of by the private players and the social sector lending is hived-off to the government. Having strategic investors participate in the private-public collaboration is an excellent option to raise capital in PSBs without burdening the economy as such.
Structural reforms: Writing-off bad loans, recapitalization and privatization of PSBs is imperative. However, these are only short term solutions to the mammoth on-going problem of NPAs. It is important to couple recapitalization, writing-off and privatization with exquisite structural reforms and corporate governance of the PSBs.
To start with, the PCA framework that has been implemented with respect to PSBs should be developed into a long-term revised plan that monitors the functioning of PSBs every financial year in order to maintain a regular check on accumulating NPAs and undertake steps for their recovery immediately. Additionally, the system of internal and external audits of loan transactions should be further supplemented with a surprise inspection by the RBI quarterly or yearly (as feasible) to assess the NPA situation from time to time.
It is also important that the government carefully maintains a good balance between incentivisation and penalization of the workforce associated with the PSBs. The minimum term of a chairperson and other key employees of such PSBs should be increased to at least 5-7 years so that the progress and/ or defaults can be closely scrutinized and the NPAs are not simply pushed to the next quarter. Tightening the rules and regulations around defaults and professional misconduct should be done immediately. At the same time, it will also be prudent to invest a considerable portion of funds in incentivizing the workforce in PSBs, increasing their monthly pay as well as year-end bonus/ rewards (instead of investing it all in recapitalization time and again). A dedicated workforce is the key to continued progress.
Intrinsic governance of PSBs: Re-engineering of banking practices in PSBs is the next step in line. In order to keep a system of checks and balances in place, the quality of risk assessment within the PSBs must be upgraded. The credit administration department of each PSB needs to be strengthened to ensure proper implementation of the RBI regulations such as the Prudential Norms on Income Recognition and Asset Classification, the Master Circular on Loans and Advances etc which are the stepping stones to healthy banking and unrelenting growth. Maintaining a higher provisioning coverage ratio and turning the defaulted loans to the mechanisms of IBC immediately will further help in streamlining the NPA prevention and recovery alike.
NPAs have been choking the Indian banking sector for far too long. However, recent initiatives and recovery programs undertaken by the government have helped us believe that there is a white light beyond the grey cloud of NPAs. Tapping the enormous growth potential of this white light will help in steady de-stressing of the stressed assets in the PSBs and lead them to a speedy recovery. If the same is not done, such PSBs will find it difficult to continue the path of improvement and will fall into the NPA trap again, sooner than later.