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Four principles to be followed in RBI’s loan restructuring

It is important to note that restoring the health and stability of the banking sector is critical to the recovery of the economy from this crisis

August 21, 2020 / 04:46 PM IST

Harsh Vardhan and Rajeswari Sengupta

In the aftermath of the 2008 Global Financial Crisis, large-scale debt restructuring had taken place in the Indian banking sector. Just about a decade later the Reserve Bank of India (RBI) finds itself in a similar situation — this time due to the COVID-19 pandemic — with demands from multiple stakeholders for a recast of the bad loans that would soon pile up on the balance sheets of banks. The previous experience had given ‘restructuring’ a bad name. Can this time be different?

In the post-2008 period, a series of restructuring schemes offered by the RBI to the banking sector had facilitated an ‘extend and pretend’ approach. The underlying asset kept deteriorating for years. When the RBI initiated an asset quality review in 2015, the non-performing assets (NPAs) skyrocketed. This episode triggered a prolonged phase of low growth-low investment in the economy.

As the RBI embarks upon a similar project, lessons from this experience should guide the current thinking. The RBI has already issued first-order guidelines that set out key boundary conditions for the restructuring scheme. A next level of filters is now required to prevent a repeat of the past mistakes. To this end, we outline four principles that we think should be embodied in any restructuring scheme that the RBI offers.