Last week’s biggest banking sector event was unveiling of the Reserve Bank of India’s moratorium exit plan for lending institutions. A senior banker told me it was also on account of the Centre wanting an escape route for banks from the coronavirus stress and the one-time restructuring of all the loans impacted by the pandemic was done with this idea.
How will it work? This scheme will give a major relief to the banking sector to gradually unwind the six-month deferral of EMI payments.
When a bank defers EMIs for six months, two issues are likely to crop up. One, it will hide the actual stress on the cash flows of the borrower. In the pandemic scenario, without the moratorium cover, there would have been defaults. This has stayed hidden so far.
Second, a prolonged moratorium can spoil the credit culture of a section of borrowers. This is especially true for smaller borrowers who look for political freebies. Some of them wouldn’t want to resume payments even after the scheme is over.
Banks were concerned about both these problems. Thus, in the absence of a one-time recast, banks would have been forced to deal with a big surge in bad loans in the post-moratorium period. This worry was addressed by the recast scheme.
Economic activity continues to be grim. In a coronavirus-hit economy, a large number of borrowers are financially stressed. Business activities have slowed down considerably. There is no certainty on when the recovery will begin and cash flows return to normal for corporations as well as individuals.
A one-time loan recast is also a political move. It saves the trouble for the political leadership from facing another major NPA (non-performing assets) crisis in the immediate future. Banks, under a board-approved loan restructuring programme, can extend the repayment period, reduce interest rates or offer an extension of the moratorium in select cases to avoid an immediate shock.
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Banks can do this after an RBI-appointed panel works out the details of the plan and can invoke the resolution plan anytime before December 31. The loan recast can be done without tagging these loans as substandard assets.
In that sense, this is an exit route for banks after moratorium period.
But the bigger point is what’s next for government banks after the restructuring?
There is an obvious additional capital requirement awaiting banks. Under the RBI’s initial guidelines, they need to set aside an additional provision of 10 per cent for the post resolution debt. This isn’t a small amount.
In case of a prolonged COVID pain, loan accounts needing resolution will be logically tougher to deal with. A resolution is only a temporary relief. It doesn’t address the root cause of the problem—demand slump in the economy.
In the worst case scenario, the RBI expects banks’ gross non-performing assets to rise to close to around 15 per cent of the total advances by March 2021.
Now the critical question—who will provide the capital for state-run banks that control 60 per cent of the industry assets?
In a recent interview to Moneycontrol, former RBI deputy governor, Viral Acharya said the ultimate solution to the asset-quality problem of public sector banks (PSBs) was in providing fresh capital and implementing reforms. It all comes down to “capital, capital and capital”, Acharya said.
A fiscally constrained government is clearly not in a position to infuse fresh capital in PSBs. The pandemic has further impacted the fiscal position as tax collections have dwindled.
The bigger banks such as State Bank of India and Punjab National Bank may be able to do some heavy lifting on their own, tapping markets but what about weaker ones in the lot?
Much of the capital infused in the PSBs in the last few years (more than Rs 3 lakh crore) has gone into repairing the cracked balance sheets of banks. The government will have to face new challenges.
In the present scenario, even with a routine capital infusion, the funding gap for PSBs will be too large. No capital will leave some of the weaker PSBs in a highly vulnerable position, forcing these banks to shrink their loan books and preserve capital. That will be counter-productive in an economy which desperately needs banks to start lending.
What is the solution?
This could be a good time for the government to shed its reluctance on privatisation and lower its majority shareholding in PSBs to make way for private capital.
As Acharya told Moneycontrol, besides capital, private participation would also ensure better governance and technology for these banks. Most importantly, this will free them of political interventions.
The government shouldn’t waste time to prepare a solid, realistic plan to start privatising PSBs at the earliest. It did well by introducing Insolvency and Bankruptcy Code.
The next should be exiting from the ownership of ‘government’ banks. The government, ultimately, has no business to be in business. The economic fallout of the pandemic is a good opportunity to look at privatisation of at least some of the PSBs.
(Banking Central is a weekly column that keeps a close watch and connects the dots about the sector's most important events for readers.)