Restructured loans after 2015: Will NPLs rise?

The Reserve Bank has disallowed banks from getting any lower provisioning benefit if they restructure loans. This is a draft rule and may kick in from April 2015. So, will banks stop restructuring altogether? Besides these, there are whole host of higher provisioning requirements and stricter conditions for restructuring and upgrading loans.

In developed markets there are only two kinds of loans - good loans and bad loans. A borrower who doesn't pay interest and principal within 90 days is a defaulter. His loan may be rescheduled, that is, he may be given more time to pay back but, it is still a bad loan and banks have to take money out of their profit and provide for the bad loan. Also Read: Restructuring of loans on rise: CARE Research
Usually 15 percent in the first year, 25 percent of the loan in the second year and fully provide in the third year.
India, however, has a third category of loans, restructured loans, neither bad nor good. The provisioning is higher for these loans - 2.75 percent but much less than for bad loans. The Reserve Bank of India has now decided to move towards the international best practice.
Starting 2015 restructured loans will no longer enjoy lower provisions. If a borrower hasn't paid monthly dues in 90 days the loan has to be marked non-performing loan (NPL) and provided it for like a bad loan even as he has give more time to repay.
Secondly for the existing stock of restructured loans, the provisioning will be increased to 5 percent by April 2015 from 2.75 percent currently. As well only restructuring will start to attract 5 percent provisioning.
The Reserve Bank has also ensured stricter calculation of loss to the bank when a loan is restructured. Upgrading a restructured or bad loan to standard will also be stricter.
Also all loans of the account will have to become performing loans for the account to be upgraded. When should a loan be termed viable and worthy of restructuring under current rules? If it shows capacity to improve in seven years for all companies and ten years for infra companies.
After 2015 it will be five years for general companies and eight for infra companies. Rolling over loans is common in banks. But loans rolled over more than two times will be considered bad.
Conversion of a loan to equity or bonds had no limits. Now there is a limit of 10 percent of the loan. Finally infra companies whose commencement is delayed are currently not marked bad. That relief continues.
Will banks see a jump in their NPLs? And will they become much more careful or wary of allowing a restructuring and therefore will industry get starved of loans itself? A distinguished panel including chairman of the Indian banks Associations and of Punjab National Bank K R Kamath, Group CFO of JSW Steel, Seshagiri Rao and Pawan Agarwal, senior director Crisil discuss the issue. Below is a verbatim interview of the experts on CNBC-TV18 Q: Since restructuring will not give you the benefit of lower provisioning, in fact the loan will have to be provided for a rate of15 percent in the first year, 25 percent in the second year and written off in the third-fourth year, do you therefore see banks becoming a little more choosy in terms of restructuring? Kamath: Let us get back to why an account should be restructured. Once you fix up a repayment period or any terms and condition for a loan, these are based on certain assumptions. If the assumptions go wrong, there are two options for a banker one is to say that the assumption has gone wrong, the account is getting bad and then you start recovering.
The other is to see that where assumptions have gone wrong, can we set it right now. Can we support this industry to come back and if it can happen quickly then we would like to look at it. That is what the guidelines say that if the borrower accounts are viable based on a restructuring package that can be done, we would continue to look at the possibility of restructuring first rather than starting the recovery steps. Q: Bankers will want to throw a lifeline in a case where they see the loan is viable, I am not saying to stop restructuring altogether but are we going to see fewer cases of restructuring because after all you also have a limited pool of capital and a limitation on your profit? If you have to take out 15 percent and set aside as provisioning irrespective of whether you are restructured or not compared to the 2 percent that was needed until yesterday, surely, your hands are tied. So, will we hear fewer cases of restructuring? Kamath: The point is should you do it today. I am a little positive, in case I have to keep 15 percent today and can bring this account back into health and get it re-compensated in the next year or a year or two afterwards, I would definitely like this option.
If everybody is coming together for a restructuring, I may have a difficulty. However, if it is a genuine case where I feel that yes, this will help it out. I am not saying here for any moment that we have unlimited capital and can continue doing that, but my first effort as a banker is to see what amount of support is required. If this support is given, how confidently can I say that this account can come back to normalcy and how fast. These will be the ingredients in taking my decision.
_PAGEBREAK_ Q: Upgradation of these loans is not going to happen quickly, a lot of these restructured assets could slip into NPLs by then, so in April 2015 if you are still staying in as the PNB chairman, you will have a fairly big stock of restructured assets, the State Bank of India (SBI) chairman will have an even bigger stock of restructured assets, some of which are going to slip into non-performing loans (NPLs), the requirements on his profit at that time will be large to provide for both incremental as well as stock, his sympathies will be limited. In 2015, will he have fewer options to restructure? Kamath: We did a study. Every quarter, out of my standard restructured book, the accounts that slipped into non-performing assets (NPA) is 12 percent and out of my NPAs restructured 14 percent of the NPAs have now got upgraded as a standard asset. It is not correct to say that the entire restructured book as on this date slips into NPA as on April 1, 2015. Two things, one is that there is a clear roadmap laid out and we have another two years to go through this. These two years will give us time to look at every account and see how to take this account out of the restructured book.

Q: It could also make you a little more averse to restructuring new accounts because we recently got a gross domestic product (GDP) forecast which is not very flattering, considering that times are going to remain difficult would you also become more wary of restructuring in the next two years because you could be faced with a problem in April 2015? Kamath: Let us look at the options. There is an account which gets into; I have an option of restructuring or making it a non-performing asset. I take the later option and make this account as an NPA and then I execute a security. What do I get out of it? Q: Will you get more prone to executing the security, to claiming your collateral? Kamath: I execute the security. It is a distress sale of assets. I don’t realise as much as it should fetch and then I am getting into a deficit in terms of the security and my balance, I take it as a loss and then what?
Instead of that, I can take 15 percent of a provision hit now and try to see whether I can help them to recover. It may not be a wise decision for a banker to jump into a conclusion. The moment the restructuring proposal comes there is a 15 percent cost on me, I will not do restructuring. Let me enforce my security. I don’t think it is a practical view. Q: Kamath is keeping up the argument that there will still be a case for restructuring. My argument is that, bankers will become a little more wary of restructuring. How do you see this as an impact on industry? Does life get tougher for you? Rao: I agree with Kamath that he is trying to give two alternatives. One, whether to go for restructuring even though it becomes very stringent going forward or treating this account as an NPA and sell it at a distressed price and book more losses. There are two options which are available.
But the bigger debate which we need to do is that when an economy is having USD 1500 per capita bringing a regulation for a country where this USD 15,000 per capita and saying that this rule is applicable in India from April 1, 2015, I think that is what we need to debate. India is a developing economy. There are a lot of risks as far as India is concerned.
In that context when industry is under stress and bringing a regulation which will become more and more stringent and put lot of pressure on the banking industry and also indirectly on the companies. It is not the right time to bring this type of stringency even though it is positive in the longer run but India is not prepared to have such type of regulation where it gets difficult for the banks to consider either restructuring or say no. Q: What do you do assuming the Reserve Bank does not have too much of an option? Maybe they will have the option of waiting another three months, maybe it is not April 2015, maybe it is December 2015 or maybe it is April 2016, I don’t think they have an option beyond that. If that is the case how will industry be able to react to this? Are you going to see a bigger case of industry getting starved of credit? Rao: We have negative impact as far as industry is concerned, because in last 15 years in India after liberalisation there are several companies which have been give restructuring and helped by the banks where they are doing extremely well today. So, if these restructuring rules are very stringent it becomes very difficult for the banks to take a call and at the same time good companies, good industries where there is a potential. In view of this stringency of norms, they will get starved for funds, not only for funds but also the good cases will not be restructured and that is a worry. Q: What is the assessment you are making on banks? Will there be a huge eating into their capital or shaving off of earnings because they have to set aside more and more for restructured assets? Agarwal: I want to give a little context on the guidelines and why we believe they have been issued at this point in time. In last two years, we have seen that the restructuring has been pretty intense. Overall, our estimate is that within two years, April 2011 to March 2013 the total quantum is likely to be close to Rs 3.25 lakh crore and we are pretty much on the way. Till December, Rs 2.25 lakh crore has already been restructured.
Another Rs 25,000 crore is already under way through corporate debt restructuring (CDR) mechanism. There will be a bilateral discussion happening. There is restructuring of SEB debt which is also underway. By March 2013, we will end up closer to the figure that we have estimated.
Also, if you look at Rs 3.25 lakh crore is more than 5 percent of the total banking system credit outstanding. Given this level of large restructuring, the guidelines are intended to ensure that the cost of restructuring goes up and to dissuade such large restructuring. We believe that the guidelines are structurally positive from a financial sector and banking sector perspective in the longer term. They do imply that in the interim the cost for banks go up.
Our estimate is that the enhance provisioning requirements till March 2015, will aggregate upto Rs 15,000 crore -given the stock of restructured asset that we estimate by March 2013 and the incremental restructuring that will still continue. Will this be material enough? If you look at Rs 15,000 crore, it is over a two year period and will represent close to 7 percent of the total profits of banks. Yes, it is going to make a difference in terms of the profitability but in a larger context from a very viable financial sector structurally financial and banking sector in the longer term, these are the steps that are good steps.
_PAGEBREAK_ Q: Do you think that by the time we reach 2015, there could be a problem of growth? The banking sector will be thinking of provisioning and growth capital. Kamath: I just want to put it in the proper perspective. A credit need or a credit demand is direct reflection of the economy. If the economy is not getting new proposals today and resultantly, there is a lower demand for the credit, one cannot attribute it as a credit aversion.
Just because credit growth is lower now, don’t attribute it to the credit aversion of the bankers. It is because of the limited opportunities available in the market today.

Q: The question is, because of stricter rules and because you have to set aside your profits for something else, will growth be a tad bit lower? Kamath: You will have to take a totality of the situation into account. Question is that, if there is a viable, lendable proposal, if I don’t lend, then why do I sit? I run a bank, my business is to mobilise deposits and lend and in the process, make my profit or try to do all these things.
However, if I take a very clear risk aversion and do only the best of accounts, it may not be available in the market in that way. Otherwise, the question is that I need to get into a lazy banking expecting to mobilize deposits and put it into government securities and sit, which is not the role of bankers. Q: However, a lot of private sector banks are doing that already but that is a different issue. Will growth suffer? Kamath: I have no right to represent anybody other than me. I am representing myself and my bank. Q: Do you think growth will take a hit? Kamath: Suppose the economy booms and the credit demand comes, the bankers will have to find ways to get the resources both in the form of capital and also in the form of deposits. If the credit demand is not that big, then probably we will balance it. Q: Other rules have also become strict in terms of promoter capital, do you think the CDR mechanism will be less resorted to because we used to see a rush of banks going in for CDR so that provisioning need not be made immediately in that quarter, now that by and by, these set of companies will require more provisioning and their upgradation rules have become more severe, do you think this rush to go to CDR sale will perhaps wane a bit? Kamath: In a way yes, because the obligations on both sides have increased now and the amount of disciplining that will come, will be much better than what it is today because there is more capital to be brought by the promoter side, the personal guarantees have been made mandatory and conversion of equity has been permitted only in case of listed companies. All these things are making it difficult for anybody to approach a CDR now or for restructuring. This is because from other side also there will be a complete appreciation of the pressure on the banks. So, it maybe a much disciplined way of getting into restructuring than what it is today. Q: What would be one point that you would like to change in this proposal? Rao: More time is required for the Indian industry and the Indian economy right now to accept such a stringent norm. Q: How much more? Rao: Maybe up to 2020. By that time economy and the industry will also be prepared to take such stringent norms otherwise it becomes very difficult either in terms of cost or in terms of availability of credits.