The Reserve Bank of India (RBI) this week released new guidelines to resolve the issue of stressed assets in the banking sector. An Overseeing Committee (OC) will be formed which will help segregate sustainable assets from non-sustainable assets. The decision to restructure will happen post this segregation. Kalpana Morpariya, MD & CEO of JP Morgan India, believes that the norms will benefit the banks. However, the new norms will not be a free ride for the companies as promoters will have to take pain alongwith lenders. “(The norms) give us a chance to move out of the logjam that we are stuck in,” says Leo Puri, MD & CEO of UTI AMC. The important part to note here is that the restructuring decision will not be taken by bankers, but by a specialized committee, he says.On the way ahead for banking sector, Morpariya says: "Look(ing) at overall penetration in the financial system, India is woefully behind.” The power of digitization is yet to fully sink in for the sector. The sector needs small banks and payment banks both. The legacy banks for now need to work out the stressed situation. First signs of recovery in core industries are visible and investment pipeline building, she says.However, Puri believes that while opportunities are there, the question is who will grab them. Even if you restructure banks and put them in place, they could topple back, he adds.Latha: The entire banking sector is going through a reset. There is the bankruptcy law in the first place which will probably become operational in a year. Before that the Reserve Bank of India (RBI) has announced rules for resetting or restructuring sustainable stressed loans and then there is a consolidation process underway and there is an ultimate rule also which the RBI is talking about that in three or four years, every bank will have to ensure that it is not exposed more than a certain level to highly indebted groups and that if it has to bring its exposure from Rs 25,000 crore to Rs 15,000 crore to Rs 10,000 crore to big companies, big groups by the year 2020-2021. So, banking is genuinely in a resetting process and to tell us how this whole course might pan out I have with me who have just been there, done that, seen it all, who have been through probably two or three decades of banking evolution in India. I have with me Kalpana Morparia, currently Managing Director of JP Morgan in India and Leo Puri, MD and CEO of UTI AMC. Kalpana Morparia has been seminally involved in the evolution of ICICI and ICICI Bank merger, 14 years to the day almost, that merger and then the old cycle of restructuring assets that went bad from 1997 to 2003 and Leo Puri as the head of the banking practice when McKinsey was actually involved perhaps with Kalpana Morparia in many of these ideas and their implementation. Below is the verbatim transcript of Leo Puri and Kalpana Morparia’s interview with Latha Venkatesh on CNBC-TV18.Q: Most recent set of rules to hit the banking sector is telling banks that you take every stressed company, divide the sustainable and the unsustainable loan and write down the unsustainable portion. What is your first takeaway about this? Is this a moral hazard? Morparia: I won’t quite describe it the way you did. I think it is in the interest of every bank to try and restructure a borrower who is currently unable to pay his debt. There can be a variety of reasons for why he is unable to pay debt but in the interest of time I won’t get into that. However, what this enables the bank to do is that when you do this assessment of a leveraged borrower and you find that in the foreseeable amortization schedule that you had given the life of the asset whatever, they are just not going to be able to sustain the level of indebtedness that they currently have, you do have an option to determine what is the sustainable level of debt that can be serviced during the life of the asset and then the balance debt is something that you could convert into a non credit instrument such that when the cycle turns, you will be able to enjoy the upside. So, I think it sets up a framework.If I might say this is not new, I distinctly remember in the 80s, way before the late 90s stress that went through, I remember even in the 80s when you really had to do with a restructuring, we were indeed talking about the sustainable level of debt and what is it that the banks could do – in those days the term lending DFIs could do to try and ensure that indeed when the cycle turns we do get the benefit of an upside rather than stay with that small spread that we would otherwise made all along. Q: You will even remember that in 2003 IDBI, ICICI and SBI sat and refinanced those three steel companies and you got the upside in Ispat, no taking away from that, debt converted to equity had its advantages, but what I am asking you is should RBI have put it in rules? When a company becomes unsustainably stressed, banks have gotten together and done this but now if you put it in a rule, bankers are telling me every minute there are phones ringing saying halve my debt?Morparia: None of this is mandatory. This is all at the option of the lender. In a stressed situation the lender clearly will have the upper hand in terms of how they want to resolve it; do they want to take the company to liquidation, do they really want to give a unsustainable debt that is not going to get serviced or is there a possibility of trying to segregate the two and getting it done, do you get it done with existing management and ownership or do you get it otherwise. Q: So you don’t think it will be a moral hazard issue? What happens is let us assume there are 10 steel companies, steel will be the obvious sector, there are three of them which are terribly stressed, three of them which are moderately stressed and four people who have actually wisely used and not over invested during expensive times, they are the guys who are not going to get this munificence and the bad boys get the munificence, you don’t think that will create legal problems? Morparia: But at the pain level to them. So, if you see the guidelines very carefully, the question of the promoters taking the pain alongside with what the banks is taking has to go side by side. So, it is not a free ride.Q: Take any X steel company, most of them have Rs 30000-40000 crore debt. Let us assume Rs 15000 crore is getting recast. If you take out Rs 7500 crore the equity will be Rs 50 crore if you want o bring down the stake of the company or take it to be Rs 200 crore, what is the stress the bank is taking, it is Rs 7000 crore that they will have to take. So, is there pain for the promoter?Puri: I think what the scheme does is it recognizes in a pragmatic way the reality and there are three elements to this which I think are persistent realities in our banking system. One is, whatever resolution we have done in any cycle, I am looking back now three cycles, forbearance always plays a role. This is a form of forbearance embedded here. Nothing wrong with that, forbearance properly used can be a good tool.Second is, whatever restructuring has actually successfully happened in India, there may be exceptions that I have not seen any, have only really been undertaken by the promoter themselves. Is this moral hazard? May be in some cases not in all. However it is actually a wise recognition that unlike other markets where third parties can come in, professionals can come in, people like the McKenzie\\'s and others can come in and carry out resolutions effectively, we are where we are. There are reasons why fundamentally if you want to restructure you need the promoter to be part of that solution, you don\\'t want him to be part of the problem, you want to ensure he is part of the solution. The balance on this moral hazard is how will you ensure that there is pain? All bailouts will carry some risk of moral hazard. Every bailout carries a risk of moral hazard because there is always a question of the guys who did well are not the ones coming with cap in hand.Q: Do you think that banks will get the upside? Will these promoters hoodwink the banks at a later stage? Somehow dilute the equity and not let them have the upside?Puri: I think the mechanism proposed here to have a committee of wisemen who will both ensure that the definition of sustainable, unsustainable are fairly carried out and prevent to some extent some of that gaming and also offer banks the cover very importantly and is see that as a third pragmatic element of this proposal because you do need banks to be protected. Reality is we have banks where bankers can\\'t make these decisions. It is a whole separate problem related to the sad state our banking system is. However this proposal accepts that. It doesn\\'t pretend that we have bankers who actually make decisions on resolutions, in the public sector bankers do not make that. It is unfortunate but that is the reality. We might as well accept that and give them a mechanism where they can make these decisions through this mechanism. This mechanism will be tested, hopefully it will ensure that there is much more value for the banks than there would have been in any other scenario. Will it be far? Only time will tell.Morparia: All of them I would say are capable, it is the system that....Q: Do you think there will be enough M&As because of this? To some extent M&As in these stressed companies are not happening because nobody wants to takeover Rs 40000 crore of debt. However if that got written down to Rs 20000 crore there may be but still will there be or will we still have to be kind to the promoters?Puri: There is actually allowance in this system where you can replace the promoter. It is not that you have to work with the promoter.Q: Do you see it happening in reality?Puri: This creates an option to work with the promoter. In some instances where that is not proving feasible you can go back and try and dilute the promoter out of existence or transfer control. I am not sure that will actually happen. If that were possible we would have seen the SDR work better than it has. SDR has been left intact as an additional tool. All of these are just about giving tools to bankers to do their job a little better. This tool to me is a very pragmatic set of tools which have been added. I think it is better than what we have seen to date. There will be some risk of moral hazard that will be mitigated by the way in which it is being designed and by this committee of wisemen.The good news is it gives us a chance to move out of the logjam that we have got stuck in.Morparia: If I might say wisemen and women.Q: What is the success rate of this sustainable debt restructuring scheme, do you expect it to be substantial?Morparia: I feel that wherever there are physical assets on the ground and for a variety of reasons which I said that we don’t have time to get into, they have got into a distressed situation. There are definitely solutions which are available, it can be the SDR, just a recast of debt, it can be part conversion of the debt into equity so that you make it more sustainable, it can be a change of management, the intention is bad then you take recourse under the bankruptcy law and basically liquidate the company.I have seen a fair degree of success in my career in banking. Where you have had the maximum problem is where the borrower entity’s intention is suspect. So, he really does not want to do anything, there could be foul play in terms of diversion of money, etc and then he just wants to hang on and then our current judicial system gives ample time to that. So, other than in those cases or where there are no assets on the ground, you are just chasing something that does not exist, otherwise by and large I would say we have been pretty successful.Q: Normally we have promoters who want to run their company well, I mean at least in the current case of stressed assets but who also have made a fast buck, do you therefore think that this is still sustainable? I am asking you because last time around there also was the advantage that after 2003-2004 we had this excellent run in the global economy and in the Indian economy. Assuming now that the global economy will limp, do you think that this swapping debt to equity will real bring too much by way of return, therefore what is the success rate of this?Puri: I think the success rate is reasonable because this is how restructuring actually happens; it happens with a mixture of promoters leading the way, forbearance shown by banks and a decision making process which allows things to move forward. I think we have all those three ingredients here. There is a risk that some people will attempt to misuse it and who knows some may succeed but the scheme does have some – there are prior filters that are put in place so projects need to be viable first of all. The discussion around what is sustainable, unsustainable needs to be fact base, the discussion around the valuation of the equity again needs to be fact based and will happen in a fact base and the pain therefore is intended to be taken by the promoter in that sense.The alignment therefore between the promoter and the bank is brought back into sync and therefore you have a chance of actually getting the engine going again. So, if those are the conditions, I think they will be able to separate out a) those are totally unviable about which we know. Those promoters who clearly are willful as Kalpana says and not intending to play game but those will be the minority. I think a reasonable number will actually work their way through. You need two other things to happen here, one of course is the general underlying recovery which cures most ills; this is what happened in fact the last time around, we were saved not so much by clever interventions but you had a recovery.Most promoters don’t set out trying to build companies that are going to go bad, they set out building companies that they think will succeed and even in those instances and I don’t know how frequent that is where there has been divergence of funds, usually they are sensible enough to diverge funds which are not going to impair the viability of the project but their calculations go wrong because the economy doesn’t operate the way there is. Fundamentally they are there to make companies are successful and work, I am not getting into the moral questions of what else happens and I think they therefore they wanted to succeed.So we have promoters who want these projects to succeed and banks who have now shown forbearance in a way that is not imploded on them, where they have been safeguarded from that and you have been smart enough to select viable projects for which there are many, we already know that there are many viable projects, I hope to see many of these things succeed.Q: Do you think that the bankruptcy law will be operational in a year? That will be the big stick to ensure that promoters fall in line?Morparia: Infrastructure is going to take time. It is very much a step in the right direction but it is not going to overnight kind of change things. However it definitely paves a way for a much better environment. However we should talk about the opportunities in banking not just restructuring.Q: What would you say are the opportunities in banking? In fact at the moment I am a little scared about opportunities because you have the payment banks coming and disrupting in a fashion. You have small banks, I guess they will only expand the horizon. You have this unified payment interface which is also going to make life difficult for the payment banks and then there is the load that legacy banks are carrying at a time when they have these nimble competitors. Where is the opportunity, I only see challenge?Morparia: The way I look at it is, if you look at overall penetration of any financial product in our system and even credit, India is woefully behind. Any other emerging market you can talk about. So, we need the small banks, we certainly need the payment banks and all the fintech revolution that is taking place. We are assuming that the banks are not going to be a part of it. If you would have asked me this question 20 years ago, you would have said ATMs and the state owned banks and you know what happened. Reserve Bank of India very carefully licensed every new branch that a private sector bank would have, that gave ample time to the public sector banks to catch on technology. So, we are constantly underestimating the ability to change and the ability for a country like India to leapfrog.20 years ago it was a McKenzie report which said that you might be able to sell a few 100 million telephones because it was going to be a rich man's instrument. Look what happened. Therefore we are completely underestimating the overall impact of all of the technology and digitisation revolution that is taking place.India has this unique capability of straightaway bypassing the brick and mortar, the desktop into a handheld.Q: To weld both these issues together, you think that given the technological disruptions and expansion and the inherited load, you see two years from now or even one year from now Indian legacy banks in a stronger place?Morparia: They will definitely need to work out the distress situation today. I disagree slightly with Leo Puri, I don't think it is as gargantuan an issue as we are making it out to be. My experience tells me that wherever there are physical assets on the ground, you need to take a pain but that pain is not 100 percent. Therefore all of the tools that we talked about just now is going to help them. I am actually seeing the first signs of recovery in what I call the core industrials. If you look at any one of the lead indicators, steel consumption, cement, power, commercial vehicles, tractors and this in an environment where rural is severely impacted by the successive droughts that we have had. We are still not seeing any investment pickup but as soon as you see this demand consumption come up Indian entrepreneurs definitely have animal spirits and you will see an investment pipeline building up.Q: Last words on how do you see this burden of challenge, burden of inherit problems and the disruption.Puri: I am a bit more concerned actually on that front than Kalpana is because these opportunities are there, the question is who is going to capture them and it is not obvious to me at this point that many of the banks that we have, the 27-28, will be able to participate in these. In fact today the outlook for their future revenue stream is very dim, it is very blur indeed. Even if you were to fully provision them and put them back on their feet, they will probably topple over again because they can’t actually earn enough to justify the capital that could have been put in. As an investor that is one of the dilemmas we have.Q: You would say that about all public sector banks or some?Puri: I would not be as sweeping but I would say a majority and each bank will develop its own strategies no doubt but this is where the real work is needed is that even if you put Humpty together again, it is not clear that it could actually walk successfully and you don’t want to put something together again and have it to put it back into ICU and this needs real serious thought. Under the current systemic constraints which they are operating, whether it is to do with people, decision making, recruiting, you know it all, I don’t see they being able to participate despite many fine individuals, just to be clear, I have no issue with that, there are extremely fine individuals in many of these banks but they are not in an environment today where they will be able to capture these, there is not enough time today to go into therefore the big elephant in the room which is around where will the future of the governance ownership lie. That is the ultimate urgent issue. Once we have dealt with this fire, we need to actually deal with that with some sense of vision and strategy.Latha: The key takeaways from our guests, 1) that the pain will look much less or at least less a year from now and much less two years from now simply because growth is underway and Indian banks in the past have shown an extraordinary ability to overcome both technological challenges as well as their inherited problems; that is a veteran banker telling you who has been there, done that and then the word of caution coming from Leo Puri that Humpty Dumpty can topple again because some part or a large part of definitely the public sector banks need serious governance changes and at the moment it is not very clear whether those governance changes are coming.
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