What is the lowdown on the directive to RBI on bad loans

The Central government has amended the Banking Regulation Act to give more powers to the Reserve Bank of India (RBI) to fast-track resolution of stressed assets in a time-bound manner. Section 35A of the Act was amended for the purpose, and two Sections were inserted: 35 AA authorises the RBI to issue directions to banks to initiate the insolvency process in case a party has defaulted under the provisions of the Insolvency and Bankruptcy Code, 2016, and 35 AB allows the RBI to issue directions to banks for resolution of stressed assets. The banking regulator has also been allowed to specify one or more authorities or committees to handle bad loans.

How did it come about

Stressed assets in the banking system, or non-performing assets (NPAs), have reached unacceptably high levels and need urgent attention, the government ordinance to amend the BR Act noted. According to industry estimates, bad loans in the banking sector could be as high as ₹14 lakh crore. The NPAs in the banking system have gone up sharply in the last couple of years, particularly after the Asset Quality Review of the RBI in December 2015. Following the review, the RBI handed out a list of borrowers to the banks and asked them to classify which of the loans could be termed NPAs.

Many public sector banks like Bank of India and IDBI Bank, to name a few, suffered huge losses owing to the exercise.

According to RBI data, gross NPA, as a percentage of gross advances, went up to 9.1% in September 2016 from 5.1% in September 2015.

During the same period, stressed assets, which are gross NPA plus standard restructured advances and write-offs, moved up from 11.3% to 12.3% and some estimates suggested it had doubled since 2013. Public sector banks share a disproportionate burden of this stress. Stressed assets in some of the public sector banks have approached or exceeded 20%.

Why does it matter

The RBI had announced several schemes in the last two years to resolve the bad loans crisis such as Strategic Debt Restructuring and Sustainable Structuring of Stressed Assets. However, owing to lack of consensus among bankers in the Joint Lenders’ Forum (JLF), the schemes could not be implemented.

The lenders’ committee or the JLF under a convener was set up to formulate a joint corrective action plan (CAP) for early resolution of the stress in accounts.

The banks have always been wary of the deep ‘haircuts’ they may have to take during restructuring of bad loans. When a bank takes a ‘haircut,’ it gives up a part of its claims on a borrower. Bankers were worried that in case a deep haircut was taken, investigating agencies like the Central Bureau of Investigation would harass them, especially if the borrower could not repay the dues even after restructuring.

Now, the RBI and the government are expected to give banks some assurance that they will not be hounded by investigating agencies if something goes wrong, as business decisions do not always yield the desired results.

Following the amendment of the Banking Regulation Act, the RBI issued a notification about the lenders (both in number and value) required in the JLF to approve a resolution proposal — to 60% from 75% of lenders by value, and to 50% from 60% of lenders by number.

The move was aimed at reaching consensus quickly.

What next

The amendment to the Banking Regulation Act is expected to force banks to take a decision under a strict time frame. However, the devil will be in the detail as the RBI is expected to issue detailed guidelines under what circumstances a loan can be restructured.

It is highly unlikely — contrary to what is speculated — that the RBI will take a call on specific accounts on the amount of haircut a bank will take while recasting the debt. In all probability, the RBI will prepare a broad framework, which the banks have to follow. At the same time, it is expected provide some comfort to the banks that bona fide decisions will not be questioned and both the central bank and the government are on board for such a decision. But, at the end of the day, it will be the bankers who will take the final call.