Non-Performing Assets (NPAs)

Why in news?
=>Gross Non-Performing Assets (NPAs) of banks rose to Rs 10.3 lakh crore in FY18 or 11.2% of advances. Banks wrote off a record Rs 1.44 lakh crore of bad loans in 2017-18.

Why did the NPAs arise in an economy?
Over-optimism:
=>A larger number of bad loans were originated in the period 2006-2008 when economic growth was strong, and previous infrastructure projects such as power plants had been completed on time and within budget. It is at such times that banks make mistakes.
=>They extrapolate past growth and performance to the future. So they are willing to accept higher leverage in projects, and less promoter equity. Indeed, sometimes banks signed up to lend based on project reports by the promoter’s investment bank, without doing their own due diligence.

Slow Growth:
=>Unfortunately, growth does not always take place as expected. The years of strong global growth before the global financial crisis were followed by a slowdown, which extended even to India, showing how much more integrated it had become with the world. Strong demand projections for various projects were shown to be increasingly unrealistic as domestic demand slowed down.

Government Permissions & Foot-Dragging:
=>A variety of governance problems such as the suspect allocation of coal mines coupled with the fear of investigation slowed down government decision making in Delhi, both in the UPA and the subsequent NDA governments.
=>Project cost overruns escalated for stalled projects and they became increasingly unable to service debt. The continuing travails of the stranded power plants, even though India is short of power, suggests government decision making has not picked up sufficient pace to date

Loss of Promoter & Banker Interest
=>Once projects got delayed enough that the promoter had little equity left in the project, he lost interest. Ideally, projects should be restructured at such times, with banks writing down bank debt that is uncollectable, and promoters bringing in more equity, under the threat that they would otherwise lose their project.
=>Unfortunately, until the Bankruptcy Code was enacted, bankers had little ability to threaten promoters, even incompetent or unscrupulous ones, with loss of their project. Writing down the debt was then simply a gift to promoters, and no banker wanted to take the risk of doing so and inviting the attention of the investigative agencies.
=>It was in everyone’s interest to extend the loan by making additional loans to enable the promoter to pay interest and pretend it was performing. The promoter had no need to bring in equity, the banker did not have to restructure and recognize losses or declare the loan NPA and spoil his profitability, the government had no need to infuse capital.
=>In reality though, because the loan was actually non-performing, bank profitability was illusory, and the size of losses on its balance sheet were ballooning because no interest was actually coming in. Unless the project miraculously recovered on its own and with only a few exceptions, no one was seriously trying to put it back on track, this was deceptive accounting.
Fraud:
=>The size of frauds in the public sector banking system have been increasing, though still small relative to the overall volume of NPAs. Frauds are different from normal NPAs in that the loss is because of a patently illegal action, by either the borrower or the banker. Unfortunately, the system has been singularly ineffective in bringing even a single high profile fraudster to book. As a result, fraud is not discouraged.
=>The investigative agencies blame the banks for labeling frauds much after the fraud has actually taken place, the bankers are slow because they know that once they call a transaction a fraud, they will be subject to harassment by the investigative agencies, without substantial progress in catching the crooks. The RBI set up a fraud monitoring cell to coordinate the early reporting of fraud cases to the investigative agencies.

Why did the RBI set up various schemes to restructure debt and how effective were they?
=>The Debts Recovery Tribunals (DRTs) were set up under the Recovery of Debts Due to Banks and Financial Institutions (RDDBFI) Act, 1993 to help banks and financial institutions recover their dues speedily without being subject to the lengthy procedures of usual civil courts.
=>The Securitization and Reconstruction of Financial Assets and Enforcement of Security Interests (SARFAESI) Act, 2002 went a step further by enabling banks and some financial institutions to enforce their security interest and recover dues even without approaching the DRTs.
=>Yet the amount banks recover from defaulted debt was both meager and long delayed. Worse, even though the law indicated that cases before the DRT should be disposed off in 6 months, only about a fourth of the cases pending at the beginning of the year were disposed off during the year, suggesting a four year wait even if the tribunals focused only on old cases.
=>The inefficient loan recovery system gave promoters tremendous power over lenders. Not only could they play one lender off against another by threatening to divert payments to the favored bank, they could also refuse to pay unless the lender brought in more money, especially if the lender feared the loan becoming an NPA. Sometimes promoters offered low one-time settlements (OTS) knowing that the system would allow the banks to collect even secured loans only after years.
=>Because promoters were often unable to bring in new funds, and because the judicial system often protected those with equity ownership, together with SEBI, RBI introduced the Strategic Debt Restructuring (SDR) scheme so as to enable banks to displace weak promoters by converting debt to equity.

Did the RBI create the NPAs?
=>Bankers, promoters, or their backers in government sometimes turn around and accuse regulators of creating the bad loan problem. The truth is bankers, promoters, and circumstances create the bad loan problem.
=>The regulator cannot substitute for the banker’s commercial decisions or micromanage them or even investigate them when they are being made. Instead, in most situations, the regulator can at best warn about poor lending practices when they are being undertaken, and demand banks hold adequate risk buffers.
=>The RBI is primarily a referee, not a player in the process of commercial lending. Its nominees on bank boards have no commercial lending experience and can only try and make sure that processes are followed. They offer an illusion that the regulator is in control, which is why nearly every RBI Governor has asked the government for permission to withdraw them from bank boards.
=>The important duty of the regulator is to force timely recognition of NPAs and their disclosure when they happen, followed by requiring adequate bank capitalization. This is done through the RBI’s regular supervision of banks.

Why did RBI initiate the Asset Quality Review?
=>Once RBI created enough ways for banks to recover, it decided to not prolong forbearance beyond when it was scheduled to end. Banks were simply not recognizing bad loans. They were not following uniform procedures, a loan that was non-performing in one bank was shown as performing in others. They were not making adequate provisions for loans that had stayed NPA for a long time.
=>Equally problematic, they were doing little to put projects back on track. They had also slowed credit growth. A dedicated team of supervisors ensured that the Asset Quality Review (AQR), completed in October 2015 and subsequently shared with banks, was fair and conducted without favor. The government was kept informed and consulted on every step of the way, after the initial supervision was done.

Why do NPAs continue mounting even after the AQR is over?
=>The AQR was meant to stop the ever-greening and concealment of bad loans, and force banks to revive stalled projects. The hope was that once the mass of bad loans were disclosed, the banks, with the aid of the government, would undertake the surgery that was necessary to put the projects back on track.
=>Unfortunately, this process has not played out as well. As NPAs age, they require more provisioning, so projects that have not been revived simply add to the stock of gross NPAs. A fair amount of the increase in NPAs may be due to ageing rather than as a result of a fresh lot of NPAs.

Why have projects not been revived?

• Risk-averse bankers, seeing the arrests of some of their colleagues, are simply not willing to take the write-downs and push a restructuring to conclusion, without the process being blessed by the courts or eminent individuals. Taking every restructuring to an eminent persons group or court simply delays the process endlessly.
• Until the Bankruptcy Code was enacted, promoters never believed they were under serious threat of losing their firms. Even after it was enacted, some still are playing the process, hoping to regain control though a proxy bidder, at a much lower price.
• The government has dragged its feet on project revival – the continuing problems in the power sector are just one example. The steps on reforming governance of public sector banks, or on protecting bank commercial decisions from second guessing by the investigative agencies, have been limited and ineffective.
• The Bankruptcy Code is being tested by the large promoters, with continuous and sometimes frivolous appeals. It is very important that the integrity of the process be maintained, and bankruptcy resolution be speedy, without the promoter inserting a bid by an associate at the auction, and acquiring the firm at a bargain-basement price.
• Bankruptcy Court should be a final threat and much loan renegotiation should be done under the shadow of the Bankruptcy Court, not in it. This requires fixing the factors mentioned in (a) that make bankers risk averse and in (b) that make promoters uncooperative.

Way Forward:
=>The RBI should probably have raised more flags about the quality of lending in the early days of banking exuberance. With the benefit of hindsight, it should probably not have agreed to forbearance, though without the tools to clean up, it is not clear what the banks would have done.
=>Forbearance was a bet that growth would revive, and projects would come back on track. That it did not work out does not mean that it was not the right decision at the time it was initiated.
=>Also, it should have initiated the new tools earlier, and pushed for a more rapid enactment of the Bankruptcy Code. If so, it could have started the AQR process earlier.
=>Finally, the RBI could have been more decisive in enforcing penalties on non-compliant banks. Fortunately, this culture of leniency has been changing in recent years.

Piccourtesy:Moneycontrol