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TOWARDS DE-STRESSINGINDIAN BANKS

The RBI has taken several initiatives to tackle the mounting bad loanproblem of banks but their implementation remains a challenge.

By Naresh Makhijani & Shailen Shah

••••••

ShailenShah

NareshMakhijani

70 BUSINESS TODAY January 29 2017

11ising corporate debt andhigher default rates haveled to a continuous in-crease in distressed loansin the Indian fmancial

system. The situation has worsenedin the last fiveyears with thestressed asset ratio rising from 7.6per cent in March 2012 to 11.5 percent in March 2016. This accumu-lation ofbad loans in the bankingsector is not the doing of corporatesalone. Poor credit appraisal. collat-eral-based lending. lack of corporategovernance and accountability andambitious credit growth targets ledto unwarranted lending by banks.Aiming to clean up stressed balancesheets ofbanks byMarch 2017. theReserve Bank ofIndia (RBI) man-dated stricter provisioning require-ments under AssetQuality Review.which led to identification of ele-vated non-performing asset (NPAs)levels in the past 12-18 months.According to an REI report. thestressed assets ratio stood at 12.2per cent at the end ofJune 2016. ofwhich 8.6 per cent ofloans are gross

~ non-performing assets (GNPAs)andCl

0: an additional 3.6 per cent are re-: structured loans.~ To tackle the mounting bad~ loan problem. REIhas undertaken;::

several initiatives. These include creating an empoweredJoint Lenders' Forum for identification of incipient stress,introducing restructuring mechanism under theStrategic Debt Restructuring (SDR) scheme, enablingflexiblerefinancing under 5:25 scheme, easing normsaround sustainable structuring of stressed assets (S4A)and revising guidelines for their sale. In addition to re-solving bad loans, these measures also seek to reduce theexclusive reliance ofIndian businesses on banks for fi-nancing requirements by improving liquidity in the cor-porate bond market.

No doubt comprehensive measures have been takento de-stress the troubled banking sector. However, thereis no visible improvement as these initiatives face chal-lenges in practical implementation.

IS 'BAD BANK' THE ANSWER?A 'bad bank', as a solution to the banking sector woes,has been under consideration. A 'bad bank' is basically abank incorporated to take over badloans from commercial banks and ena-ble the lender community to focus onlending as stretched non-performingloans prolong the healing process inthe organisation. Outside India, devel-oped economies like that of the UK andthe us have adopted 'Good Bank BadBank' approach as a successful restruc-turing and accelerated resolution tool.China set up state-owned asset man-agement companies (AMes) during thebanking crisis in the late 1990s tooversee non-performing loans and theprocess delivered good results. TheseAMCs helped rejuvenate China's economy by turningdelinquent borrowings into state-owned enterprises.

The bad bank concept is not entirely new in India.When IDEI Ltd converted into a bank in 2004, the gov-ernment set up a Stressed Asset Stabilisation Fund(SASF) to hive offits stressed and non-performing casesworth ~9000 crore. The idea was to separate stressedloans of the bank through the SASF, which would focusentirely on fund recovery while the bank would con-tinue to function as an entity free of any large bad loans.According to a report by the Comptroller and AuditorGeneral of India, SASF could recover only ~4000 croreby the end ofMarch 2013. This indicates segregation of

good and bad debt isn't enough to solve the bad debtproblem. Though it creates a good balance sheet, it doesnot necessarily solve the ground level problem of recov-ery. It is sometimes also seen as a 'moral hazard' shield-ing banks from their own inconsistencies and failure totake proper precautions.

A bad bank may have been a solution in other coun-tries, however, certain aspects will have to be consideredwhile evaluating the need to set up one in India. Stressin the Indian fmancial sector is concentrated in publicsector banks, which would require capitalisation andfunding to flow from the government. One could saythat a proxy ofbad bank exists in India under the S4Ascheme, which account-wise segregates healthy andunhealthy portions of a debt. This can be supplementedfurther by developing a market for stressed asset sale forARCs. A secondary market for securities issued by ARCscan also be a source of additional capital in the system.

RBIINITIATIVESJoint Lenders Forum (]LP) is similar to'London Approach' and focuses onidentifying and remedying stress in ini-tial stages and avoiding bad loan write-offslater. It works as an out-of-courtsettlement mechanism for consortiumlending and Multiple BankingArrangements (MBAs) where lenderscome together and form aJLFcommit-tee to arrive at a corrective action planand preserve the economic value of theunderlying asset. However, in manycases, decision-making within the stip-ulated time has been a challenge for JLF

committees. The 5:25 refinancing scheme is introducedas a flexiblestructuring scheme enabling lenders to peri-odically refinance term loans with a long gestation pe-riod. The scheme allows banks to correct the asset liabil-ity mismatch for a long term project based on its eco-nomic life.This, in turn, helps in easing cash flows andreducing fmancial stress in the stabilisation phase of theproject. Initially only existing and already installed infra-structure and core industry projects were eligible for refi-nancing under the scheme. This restricted resolution forstalled projects in other sectors as well as new infrastruc-ture projects. In an attempt to address this challenge, theRBIrecently revised the scheme, opening it to new pro-

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jects in all sectors and reducing the aggregate exposurefor existing project loans to '\250 crores to be eligible forrefmancing under the scheme.

The Strategic Debt Restructuring scheme allowslenders to initiate change in management, gain controlby converting part of the loan into equity and turnaround the ailing company. It was observed in restruc-turing cases that borrower companies were not able tocome out of stress due to operational/managerial ineffi-ciencies. By allowing lenders to change the manage-ment and ownership, SDR enabled lenders to removethese operational and management inefficiencies. Thesuccess of SDR depends on successful turnaround of thecompany, which requires a disciplined approach andboard oversight function. Even though it has been apopular recourse amongst the lender community, lend-ers have faced difficulties in its successful implementa-tion due to lack of adequate expertise,time and resources to run the distressedcompany. Also, a significantly discountedprice expected by potential buyers, giventhe 'fire sale', unsustainable levels of debtand lack of reliable information to make avalue assessment have made it difficultfor lenders to find new promoters.

Scheme for sustainable structuring ofstressed assets (S4A) was formulated bythe RBI to give companies a chance forsustainable revival and ensure ade-quately deep financial restructuring. Thescheme provides lenders an option to bi-furcate existing debt of stressed borrowersinto sustainable and unsustainable portions. It is one ofthe first initiatives which acknowledged the need ofbanks to take haircut on the stressed loan by convertingunviable portion of debt into equity. Though the schemehas been welcomed by the lender community, banks tillrecently kept debt ridden accounts on standby, effec-tively delaying the scheme's implementation in thewake of expected changes for smoother application. TheRBI recently revised certain aspects which are expectedto push banks to implement the scheme.

EVOLUTION OF ARCsUnder the recently announced guidelines, the REI hasmandated banks to put in place internal policies for assetdisposal, conduct periodic review of doubtful assets andset selling targets. Banks will also have to lay downnorms for disposal of stressed assets, endorse discount

factor and obtain valuation reports to justify the dis-count factor. These norms will empower banks in assetsale. It will thereby spur distress asset sale transactionsas well as result in more deal certainty for buyers.

ARCs have come a long way since their introduc-tion in India. They were introduced under theSARFAESI Act of 2002, which empowered them to takeover NP As and enforce security of the loan withoutintervention of the court. The regulatory environmenthas witnessed a gradual transition to facilitate ARCs toplay a crucial role in the financial sector and create anactive market for distressed asset transactions. Eventhough steps have been taken, the key challenges ofcapital constraints and valuation mismatch betweenbanks and ARCs have historically resulted in mutedgrowth in distressed asset sale transactions,

Interest from foreign shores in the ARC marketlandscape has been growing with manyglobal investors participating in India'sdistressed debt market space. Recentregulatory changes - allowing 100 percent FDI in ARCs - and revised guidelinesto incentivise proactive sale of stressedassets are expected to further boost theparticipation of ARCs in the revival ofstressed assets.

IMPACT OF DEMONETISATIONPrime Minister N arendra Modi's surpriseannouncement to scrap '\500 and'\1.000 notes may have spiraled a senseof panic and confusion across the coun-

try, but it may help banks in resolving their bad loanproblem. Even though in a limited manner, there havebeen instances post November 8, where defaulters areusing old notes to settle their overdue debts with thebank. This could set the pace for some good recoveries.

WAY FORWARDThe first step in the direction of addressing the growingdebt pile in Indian banks has already been taken by theRBI. Proper implementation of these measures alongwith the newly ushered Insolvency and BankruptcyCode, 2016, will give more power to lenders to resolvethe distressed assets situation, and is expected to lead totime-bound recovery from stressed assets .•

Naresh Makhijani is Partner & Head, FinancialServices and Shailen Shah is Director, Deal Advisory

at KPMG in India). Views are personal

January 29 2017 BUSINESS TODAY 73