Opinion | Hope trumps reality in new NPA resolution framework

Hope is the operative word in the new bad loan resolution plan drawn up by a committee of bankers from state-owned lenders. Hope that there is a large market of private investors waiting to buy stressed assets, hope that bankers will quickly arrive at a consensus on pricing distressed assets, and hope that banks will clean up their act in dealing with smaller stressed loans in a time-bound manner.

The panel has recommended classifying bad loans in three buckets: The first category is loans below Rs 50 crore. Here, the onus of resolution lies on individual banks. The solutions proposed here are prescriptive in nature. They consist of good-to-do things like setting up a separate vertical for SME loan resolution, a monitoring and review mechanism, and a standard operating procedure. But there are no operational guidelines. There is nothing radical here to resolve the Rs 3.1 lakh crore stressed assets in this bucket. If banks haven’t already done some of these things, they should be taken to task.

In case of larger loans (between Rs 50 crore and Rs 500 crore) where the exposure is held by multiple lenders, banks will have to get together to resolve the loans. What’s new here? Banks will have to enter into a so-called inter-creditor agreement to arrive quickly at joint decisions. Debt resolution plans will have to be approved by 66 percent of creditors by value of exposure. That sounds similar to the erstwhile joint lenders forum (JLF) mechanism, which didn’t exactly have a great track record.

For the largest bucket of loans over Rs 500 crore, the panel has proposed an asset management company (AMC) which will raise funds from institutions, acquire and operationally turn around stressed assets along with acting as a market maker. That sounds like a bad bank with another name.

Bankers are at pains to explain that the AMC structure is different because assets will be transferred at market value, i.e. after a haircut, through an open auction where existing asset reconstruction companies can also participate. Secondly, bankers say that the current model is superior because banks will get full payment for these stressed assets (after the haircut) within 60 days. Currently, most sales to asset reconstruction companies happen at a 15 percent upfront payment and the remaining in the form of so-called security receipts. These security receipts have a poor record of redemption.

Banks also have the option of buying a stake in the asset management company/alternative investment fund if they wish to book gains after the asset value recovers over a period of time. But that begs the question of why banks would sell an asset in the first place if they believe that its value would recover.

In the end analysis, the new plan is just about tweaking old models like a JLF or bad bank. The assumption here is that a large pool of private investors will rush to buy distressed assets if two issues are solved – better pricing through a market mechanism and consolidating assets under the asset management company.

Selling at a haircut will require banks to book steep upfront losses, which will boost capital requirement. According to Udit Kariwala, associate director at India Ratings and Research, state-owned banks will require about Rs 98,000 crore to maintain an 8% common equity to risk-weighted assets (CET1) ratio at the end of this financial year assuming 60% provisions for their corporate loan books and incremental slippage. With only Rs 65,000 crore left in the government’s Rs 2.11 lakh crore bank recapitalisation kitty, there is a need for more capital of close to Rs 35,000 crore, or banks risk facing consolidation or closure.

Getting rid of Rs 10 lakh crore worth of bad loans from bank balance sheets is only the first step on the path to recovery. There needs to be efforts to improve corporate governance and risk management at state-owned lenders. Large firms have alternative sources of funds, but for the small and medium enterprises sector, a healthy banking system is a must.