Timely recognition, resolution of bad loans must: Experts

Bad loan, or borrowers not returning the money, is the one of the major issues hurting the banking industry. CNBC-TV18 recently conducted a survey of 13 largest banks,  and the result showed a 43 percent jump in bad loans in the first half of this fiscal.

Recently, RBI Governor Raghuram Rajan stressed on the need for banks to redress the situation and said guidelines would issued shortly to tackle the problem.
"We have to ensure that the system recognizes financial distress early, takes steps to resolve it, and ensures fair recovery for lenders and investors,"  he said.
"We could wish for a more effective judicial process or a better bankruptcy system, but while we await that, we have to improve the functioning of what we have. In the next few weeks, we will announce measures to incentivise early recognition, better resolution, and fair recovery of distressed loans," he said. 
The governor identified a three-step process to control non-performing loans (NPLs); one,  incentivise early recognition, two, better resolution and three, fair recovery where you can't resolve.
But what comes in the way of early recognition? Why are PSU banks saddled with more bad loans than new private sector banks? What can RBI do to incentivise early recognition and quick resolution? To answer these and other questions, Diwakar Gupta, the former MD, State Bank of India, SL Bansal, chairman of Oriental Bank of Commerce and Ashvin Parekh, national leader Ernst & Young spoke to CNBC-TV18 in a panel discussion.
The problem is more severe at public sector banks than private sector banks. Public sector banks account for 75 percent of total bank credit but today they account for 86.1 percent of the total non-performing assets (NPAs) in the system. The numbers get a worse when you combine gross NPLs and restructured assets. In public sector banks the percentage to the total amount of bad assets, if you count restructured and NPA is 11.1 percent whereas for new public sector banks it is 3.1 percent of their total book. So, there is something slightly more problematic in public sector banks and maybe the low hanging fruit is to find out the different from the private sector banks.
There were a couple of takeaways from the discussion. One, there should be time bound recognition and resolution of bad loans, so that the value of the asset doesn’t simply erode. Some forbearance and a belief that decisions are taken in good faith helps the private sector where writing off of 20 percent so that getting Rs 80 atleast out of Rs 100 is seen as positive. That forbearance needs to come and it is for the RBI and the government and bank chairman to check out how this can be ensured. Also, there should be performance based compensation as recognition for some good work done. Below is the verbatim transcript of the panel discussion on CNBC-TV18 Q: What do you think is the primary problem leading to a larger NPL in the public sector banks? Gupta: Some of it is legacy. The reason being that in the downturn that we saw while private sector banks were hit very hard, public sector banks actually flourished in a flight to safety and therefore, there could have been some lowering of the guard on public sector banks and the chicken is now coming home to roost.
The problem is more complex. For public sector banks 20 percent of the problem definitely is in execution. If we were to execute better in terms of timely follow-up and proper connect with the borrowers, recovery would be better on retail, SMEs, agriculture.
There definitely is a major problem with decisioning when it comes to resolution. Here I think the character of public sector banks puts a premium on conservative decisioning.
While there is no reward for a quick decisioning in favour of a resolution for example if I were to settle for a 70 percent one time settlement (OTS), I would be risking being questioned for a 30 percent write off to the customer. Q: At the moment the public sector banks, restructured plus GNPL – gross bad loans, is 11 percent compared to 3 percent for new public sector banks. According to you, why is this disadvantage for public sector banks? Bansal: There is difference between business models. Other than ICICI Bank, all other private sector banks - HDFC Bank is an old private sector bank and other private sector banks are new private sector banks. From 2004 onwards when liquidity was abundant in the system and all the banks were funding aggressively for the infrastructure, at that time private sector banks business model was not like that. Only ICICI Bank was funding the infrastructure projects. I don’t think HDFC Bank or any other private sector bank, whether it is Kotak Mahindra or Yes Bank or Axis Bank have gone in an aggressive way for funding infrastructure.
Secondly, two things happened in 2008-09. One, Rs 60,000 crore worth of assets have been provided by the government and the agriculture debt waiver was permitted. Two, one time restructuring exercise was permitted and with the result most of the overdue assets and all those assets were restructured, even small assets were restructured which in any case were practically NPAs. So, those three years period was very good for the banking industry. Now all these chickens are coming out of the basket. Since economy is slowing down the decisioning process has slowed down. The economy is not doing well, capital formation which was close to 36 percent and we were growing at 9 percent, capital output ratio was 4:1. Now at 28 percent, capital formation should grow at 7 percent.

_PAGEBREAK_ Q: Since you observe both these banks and you are an advisor to both sets of banks in different scenarios, is there something besides what SL Bansal and Diwakar Gupta are saying that creates more problems for public sector banks? Parekh: There are two parts to it. One is the hard part which is working out of evidence and data. The other is soft issues, which is more behavioural in nature.
As far as the hard part is concerned, the MIS, the quality of information and the quality of data that is available at the private sector banking level particularly the progressive first five of them - the old private sector banks perhaps may behave a little differently. Q: Now, even the public sector banks have core banking solutions. So, should data mining be an issue? Parekh: It should not be an issue but there are two parts to it, one is the availability of data and the use of data. Secondly, as far as the soft issues, behaviour part is concerned, the behaviour is if I go out and identify then I have to solve it. I have to go about doing something.
When I am at the grass root level that is one thing about public sector banking which I feel is stronger compared to private sector banking and the grass root feel is far more stronger. The only issue is admission of any kind of issues that may arise out of it.
If the governor is talking about incentivisation that is to be addressed. Q: There is more courage, more hard heartedness in the part of private sector bankers. For instance one of the management’s guru pointed out that in the case of Kingfisher the private sector bankers, some of them ensured that credit card payments to tickets are escrowed to their accounts. So, they got first charge of that money whereas public sector bankers had to wait for Kingfisher to repay them to that extent their NPLs increased whereas the private sector bankers could control. Also, this comes from retired public sector bankers that the courage to go and say I am just seizing your assets, to be hard, hard hearted is less in the case of public sector banks, would you agree? Gupta: I fully agree and that is part of the execution problem that I said. Even if you take the case of Kingfisher and you take the receivables on tickets through credit cards, they are a fraction of the percentage of the total exposure. I agree with you that there are certain things that private sector banks get absolutely right.
Firstly, they are lending where the asset quality is better. Public sector banks are usually in working capital. Working capital assets deplete faster when there is a problem.
Overall, it is the decisioning and the fleet footedness – being able to get into the problem in real time and being able to resolve it in real time is the problem for public sector banks. The courage to take a decision is the key.
When personal goals and organizational goals do not converge, it is the personal goal which will always triumph the organizational goal.
If I have the fear that six year into my retirement I can be questioned by CBI or CVC or RTI, I am not going to take a decision come what may and the borrower or the unit can go to hell, I can file a civil suit and retire in peace, that is the crux of the matter. Q: You were to give me examples about if I were to get 70 percent recovery earlier and I settle for it I could be questioned. Can you just exemplify what would a banker inevitably do since he is going to be questioned for the 30 percent write off? Gupta: You send the proposal back on the drawing board, make it better, make it 80 percent, go back and discuss among the consortium members, discuss with the borrowers, you lose another 18 months and by this time the thing is completely unviable.
So, there has to be accountability for indecision or delay or conservative decisions. It is harder to implement than to say but that is the crux of the problem. Q: The behavioral issue, is it time that the government as shareholder and Reserve Bank as regulator opened its eyes and demanded that work conditions for public sector bankers change? Parekh: The first thing and the most important part is the entire behaviour issue of running after the banker rather than the borrower has to change. Then again, there are other issues associated with public sector banking or even private sector banking in some cases is the collateral management. In secured lending, that is what we are talking about in the Indian banking then the security that is offered by the borrower must be pressed; the entire system has to work in keeping with it. We find that the systems have loose ends in various parts. Q: Infact at micro loans, you ought not ask for collateral up to Rs 10 lakh. Parekh: That is micro loans but I am talking about mid size and large size borrowers for instance who account for a large part of the NPAs that we are talking about. Then I suppose some bit of that is essential. When you come down to the behavioral part, when you want to incentivise you have to recognise this as one of the attributes of performance. In as much as your targets and so many other things recovery and early recognition – more than recovery the early recognition of a loan turning sour has to be incentivised. Q: Is it possible to enforce collateral or increase collateral requirement rules? Is that a low hanging fruit? Bansal: For a mid size company which is availing at advance of say Rs 1 crore to Rs 40-50 crore you can always ask for the collateral. However, for these project specific loans you will not have any collateral and all these priority sector loans that are below Rs 1 crore, you cannot ask for collateral. Even where you are having collaterals enforcement of this collateral, it is becoming a big problem.
When the Securitization and Reconstruction of Financial Assets and Enforcement of Securities (SARFAESI) Act was introduced and this Debts Recovery Tribunal (DRT) was established it was assumed that the cases will be settled within six months tome or nine months time or maximum one year’s time. Cases are going on adjournment after adjournment. There is no accountability on the part of DRT. I don’t know what the bankers can do in that.

_PAGEBREAK_ Q: I agree that DRT is a big issue but if you as the management or regulator cum shareholder simply said that we are asking for more collateral rules, is that possible at all, is that a loop hole that can be rule wise filled up? Bansal: In my opinion bankers should not look at collateral. The proposal should be seen as viability based on the cash approvals. If the collaterals are available then we float all the norms and then we don’t look at the cash flows and other things. The proposal should be evaluated based on the cash flow and then collateral provides comfort only. We are not in a business of disposing of the security and recovery our dues, we are in a business of making money out of the cash flows. Q: How would you incentivise early recognition? In your performance appraisals at this point in time how much of your compensation is linked to how much of loans you bring in? Is there a variable component and can that variable component be tied to early recognition or early resolution? Gupta: As all of us know in the public sector, performance led incentives are close to zero. Therefore, there is nothing that can be tied up. Early recognition is a very subjective thing. Could something have been recognised early so as I said fixing accountability on this is very hard even though you may say you can do it.
I think more than early recognition, timely decisioning something that needs to be enforced. There has to be mechanism to ensure time bound decisions on both these categories. I know many cases where a loan could have been rehabilitated but the delay posted to death, I know many cases where timely cut off could have got 50-70 percent of the outstandings. You are ultimately left with a suit filed and prospect of getting 10 percent after three years. Q: If I was allowed to resolve or if the world was not after me I would have taken that 30 percent write off and got atleast 70 percent of my loan back. There is the flip side, there is always the fear that the banker in question and he is far away from head office could be in connivance with the borrower and both are merrily siphoning off the system for that 30 percent which they are splitting. Can you give a blanket protection to bankers, yet there is the honest banker or a larger number of honest bankers, so can this dilemma be resolved? Gupta: Where malafides are suspected authorities can check. Where malafides are known, the market knows it, regulators have all the power to go after specific cases but if there is a fear that you may be wrongly targeted for whatever reasons malafide or bonafide then decisioning won't happen. Q: But that is very discretionary, isn’t it? Gupta: It is. So, my short submission to you is that no amount of CVC or enforcement stopped a corrupt man from being corrupt. It only stops the honest man from being quick and decisive.
There is a very large case for saying that if there are bonafide decisions taken people should not have summary powers to question the bonafides. The last thing I want is my integrity to be questioned.
For the larger loans it is not that a person can do it individually in connivance with a borrower. There is a structure, there are consortia, there are multiple lending where you have 5 or 6 bankers, all 6 cannot be in connivance.
Infact I was asked to head a committee by the department of financial services, I was the chairman of the committee to suggest ways how consortia or multiple lending arrangements could work better and the only recommendations we have given there is that you must have a timeframe in which a decision will be taken. Today, otherwise a consortium discusses, then each banks board has to approve, that process itself takes 7-10 months after which things come back and after an agreement some bank still says I am not going to adhere to this. So, that is where we are falling through on rehabilitation likewise on resolution. Q: What is your list of steps that is plausible within the current situation? Bansal: I don’t understand how we are going to incentivise the early recognition. Who will decide when it is to be recognised because there is a laid down procedure, after 30 days the account comes under early alert system then after 60 days SME and then after 90 days it is switched to NPA category. Q: On the 31st day when the first interest has not been paid, is there a lot of effort by the system to recognize stress and resolve it? Bansal: It depends on the individual. Some branch managers are putting extra effort and that is why they are in a position to control the NPA in their branch and ultimately, collectively the banks as a whole, the performance is much better. While some branch managers are very comfortable and they don’t follow it with the borrowers specially this happens in the small and mid-sized accounts.
However, providing incentive for early recognition I don’t know how we are going to do that.
The RBI governor may be referring that you should not go for ever-greening of the laws. But suppose the account slips to NPA category and the borrower comes to the bank after account slips to NPA category that as on date I am ready to give 80 percent of the amount outstanding, first of all the banker will be afraid that the account has just slipped to NPA category.
If I settle for 80 percent and I put a write off of 20 percent then there will be a huge problem and people will say he is hand in glove with the party. This is the real problem in public sector. In private sector bank they immediately decide the means of the borrower and then take a call and get rid of that account. That is the basic difference between public sector and the private sector. Q: Do you have any ideas on how this entire system of recovery tribunals can be speeded up? Parekh: Somewhere along we will have to device a method of rewarding the persons who are actively managing the accounts. We have not done it in the past, we say it is a major limitation but now recognising that is a limitation isn’t enough. Q: Will it be a performance based compensation then?
Parekh: Yes some kind of performance based compensation or atleast recognition if not just money incentive.