Dhananjay Sinha Emkay Global
The much hyped and anticipated measures to address the persisting NPA issues of the banking sector, especially PSU banks, have come in as a dampener with the ordinance failing to meet expectations.
The heightened decibel ahead of the announcement triggered a major 10-25 percent rally in PSU banks stocks. But quite like the earlier occasions, the ordinance announced on Friday (The Banking Regulation (amendment) ordinance, 2017) lacks adequate substance and can be considered as incrementalism at best.
Specifically, through the ordinance, the central government has authorized RBI to issue directions to the banks to initiate insolvency process in respect to defaulting companies under the Bankruptcy Code.
Secondly, RBI has also been empowered to issue directives to the banks to resolve stressed assets. And third, RBI may specify one or more authorities or committees to advise banks on resolving the stressed assets.
Clearly, the above provisions fail to induce much confidence towards resolving the crippled PSU banking sector.
Also Watch: How Banking Regulation Act will clean up India’s bad loan mess
One, giving RBI more power to direct banks sounds somewhat stale as under the previous governor Raghuram Rajan in FY17, RBI had aggressively instructed the banks to clean their balance sheets under the Asset Quality Review (AQR) mechanism. Read differently, the ordinance also gives an impression that earlier banks lacked the will to address the problem of bad loans.
In the past, various schemes such as 5/25 Restructuring Scheme, Strategic Debt Restructuring (SDR) Scheme and the S4A scheme have proved ineffective. Hence, a possible motive behind issuing the ordinance could also be to bring an end to the decision-making paralysis among bankers on bad loan resolution.
Consequently, just like the Asset Quality Review and Increased Disclosures on Divergence Accounts, the RBI can push banks to invoke bankruptcy, which in turn can put pressure on corporates to come forth for resolution. This could at least hasten the decision making on such assets.
Second, the core issues of recapitalisation of PSU banks remain unaddressed. How would the capital-starved PSU banks fund the potential losses/haircuts on these bad loans?
The track record on recapitalisation front has been patchy. Notwithstanding the high decibel created earlier on the INDRADHANUSH package (August 2014), which was touted as the biggest banking sector reform post-independence, the problems of PSU banks have lingered and worsened.
As per the latest Economic Survey (February 2017), the stressed loans of the PSU banks has scaled to a high of 20 percent of advances, implying that un-impaired Tier 1 capital position is still negative for several PSU banks.
Under these circumstances, PSU banks have seen their loan book either contracting or growing below industry average, thereby losing market share to private players. With latest measures failing to address the recapitalisation requirement, PSU banks will continue to be challenged on growth front.
Gross NPA (% of Gross Advances)
Total Stress (% of Advances)
Third, through the ordinance, the government has also disregarded the suggestions made by Chief Economic Adviser Arvind Subramanian and RBI Deputy Governor Viral Acharya on creation of bad bank viz Public Sector Asset Rehabilitation Agency (PARA), participation of private capital through private asset management company (PAMC) and National Asset Management Company (NAMC).
Both authors have identified the seriousness of issues relating to "twin balance sheet" problems of overleveraged corporates and impairment of PSU banks.
Growth potential and positioning matrix of banks (Feb 2017)
(Note: LGD* aggregated assuming loss on stress assets= 100 percent for NNPL, 30 percent for restructured assets, 50 percent for 5/25, 50 percent for SDR and 30 percent for security receipts; ^Growth potential= Tier 1- LGD/Risk weighted assets; Data for security receipts for ICICI Bank, Yes Bank and Federal Bank is as per the latest quarter; Retail loans as % of total loans (including international loans) includes business banking loans classified as retail loans)
Clearly, policy measures announced thus far, including the latest ordinance, have failed to create adequate confidence on resolution of banking sector sticky assets that have lingered on since 2009. In a way, the modest provision of Rs 100 billion in the Union Budget FY18, also indicate that the fiscal constraint in recapitalisation of the PSU banking sector.
In my view, there has been considerable dithering on taking a frontal attack on the impairment issue, the resolution of which lie in taking serious haircuts on bad loans, transferring the residual to a bad bank for long term resolution, consolidation of PSU banks and massive fiscal provisioning to recapitalise them.
By contrast, incremental news flows on farm loan waiver across several states indicate that that the problems for PSU banks can sustain further. Evidently, market enthusiasm on PSU banks seen in recent quarters can be exposed to some serious normalisation.
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