Indian Banking Moving towards a new landscape - Regulatory Mechanisms - Part - 8

Regulatory Mechanisms

Part 9

Indian Banking Moving towards a new landscape


RBI has progressively made it easier for banks to recognize and deal with loans extended to distressed projects. RBI offers a lot of flexibility to banks in dealing with the stressed asset problem. In this regard, RBI has introduced several measures including an early warning database of large loans, the Joint Lenders Forum, the Strategic Debt Restructuring process and the 5/25 mechanism, etc. RBI has been making constant efforts to enable banks to improve the quality of lending. Keeping in view the importance of credit discipline for reduction in NPA level of banks, banks have been advised to scrupulously ensure that their branches do not open current accounts of entities which enjoy credit facilities (fund based or non-fund based) from other banks without specifically obtaining a No Objection Certificate from the lending bank(s). Banks should take a declaration to the effect, that the account holder is not enjoying any credit facility with any other bank.


RBI realizes that Information sharing is a very critical aspect in financial transactions and any gap in information can transform into risk cost for the bank. In this regard, Credit Information Companies (CICs) play a major role in information sharing. Banks and Financial Institutions are required to submit the list of suit-filed accounts and willful defaulters of Rs. 25 lakh and above every quarter to CICs. CICs have also been advised to disseminate the information pertaining to suit filed accounts and Willful Defaulters on their respective websites. The banks / Financial Institutions have been advised to furnish the data in respect of willful defaulters (non suit filed accounts) of Rs. 25 lakhs and above to CICs on a monthly or a more frequent basis with effect from December 31, 2014. This ensures that such information to be available to the banks / Financial Institutions on a near real time basis.


Further, the Central Electronic Registry under SARFAESI Act became operational on March 31, 2011 with the objective of preventing frauds in loan cases involving multiple lending from different banks on the same immovable property. As per the new norms, transactions relating to securitization and reconstruction of financial assets and those relating to mortgage by deposit of title deeds to secure any loan or advances granted by banks and financial institutions, as defined under the SARFAESI Act, are to be registered in the Central Registry. The records maintained by the Central Registry will be available for search by any lender or any other person desirous of dealing with the property. Availability of such records prevents frauds involving multiple lending against the security of same property as well as fraudulent sale of property without disclosing the security interest over such property.


Despite the information sharing mechanisms (as detailed above), if the loans were to still go bad, restructuring mechanisms have been spelt out to help a borrower who has a viable project or a viable business proposition. With a view to putting in place a mechanism for timely and transparent restructuring of corporate debts of viable entities facing problems, a Scheme of Corporate Debt Restructuring (CDR) was started in 2001 for quicker recovery/ restructuring of stressed assets. Under a corporate debt restructuring plan, the lenders give the company, the benefit of reduced interest rates and a moratorium period for repayment, and in some cases, lender sacrifice a part of the principal amount.

RBI recently announced the SDR scheme to address some of the gaps in the CDR scheme. As per the new norms under SDRS, the lenders will have the right to convert their outstanding loans into a majority equity stake in a defaulting company if the company fails to honor its debt commitments agreed under a restructuring plan. It is expected the SDRS will enhance the bargaining power of banks during debt restructuring negotiations and ensure better compliance among borrowers with their restructuring plans.



In the backdrop of the slowdown of the Indian economy resulting into stress to a number of companies / projects and increase in Non-Performing Assets (NPAs) and restructured accounts in the Indian banking system during the recent years, a need was felt to recognize the stress in the economy early on a real time basis and take preventive and / or corrective actions in order to preserve the economic value of banks' assets. In view of this, the Reserve Bank envisaged and released the 'Early Recognition of Financial Distress, Prompt Steps for Resolution and Fair Recovery for Lenders: Framework for Revitalizing Distressed Assets in the Economy' on January 30, 2014. The framework outlines a plan for tackling distressed assets, covering early identification, quick restructuring and recovery.


The Framework outlines an early recognition of stress in all large value accounts and their reporting to a Centralized repository at the RBI for dissemination among all the concerned lenders for taking corrective actions as per the broad guidelines given in the Framework. Accordingly, a Central Repository of Information on Large Credits (CRILC) has been set up in April 2014 to collect, store, and disseminate credit data to lenders. Banks are required to furnish credit information to CRILC on all their borrowers having aggregate fund-based and non-fund based exposure of Rs. SO million and above with them. Notified systemically important non-banking financial companies (NBFC-51) and NBFC-Factors are also required to furnish such information. CRILC's essential objective is to enable banks to take informed credit decisions and early recognition of asset quality problems by reducing information asymmetry.


Regulatory mechanisms for recovery - A bank begins a debt recovery process when it seeks money it is owed. A bank takes recovery action for a number of reasons, but the most common is when a customer fails to make loan repayments. Debt recovery may include - Referring the matter to a specialist debt recovery team within the bank, employing an external debt collection agency to act on its behalf, selling property over which the bank holds security, seeking a judgment from the courts to enforce the debts. In the event, the bank is unable to recover the loan through its internal or external collection teams it can initiate some of the steps mentioned below -


a. Troubled Banks largely turn to the Official Liquidator, a government-appointed officer attached to the country's high courts, who administers assets and oversees liquidation. However, this process of recovery is slow and takes a minimum of five years and can take up to 10 years, by which point there is virtually no value left in the asset. Further, the current legislation, especially the Sick Industrial Companies Act of 1985 is geared towards reviving companies, so appeals frequently follow a wind-up order results in virtual paralysis.


b. Recovery through Debt Recovery Tribunals (DRTs) - RBI along with the Government, has initiated several institutional measures to speed up recovery of bank loans. Prior to 1993, banks had to take recourse to the long legal route against defaulting borrowers, beginning with the filing of claims in the courts. Many years were therefore spent in the judicial process before banks could have any chance of recovery of their loans. Subsequently, Debt Recovery Tribunals (DRTs) were established consequent to the passing of Recovery of Debts Due to Banks and Financial Institutions Act, 1993 to assist the banks in the speedy adjudication of matters relating to recovery of NPAs of Rs. 10 lakh and above. Appeals against orders passed by Debts Recovery Tribunal (DRT) lie before Debts Recovery Appellate Tribunal (DRAT). Presently, there are 33 DRTs and 5 DRATs functioning all over the country.


The recent amendments to DRT Act vide the Enforcement of Security Interest and Recovery of Debts Laws (Amendment) Act, 2012 have been carried out to improve the functioning of the DRTs, to prescribe time frame for filing of pleadings, adjournments etc. and to give recognition and validity to the settlements/compromises entered into between banks and borrowers. Within a lesser period than a decade it was observed that DRTs could not give desired results and a need was felt that banks should be given adequate powers to recover their dues without intervention of Courts and Tribunals. SARFAESI Act was brought into existence in 2002. It was indeed a good piece of legislation which gives adequate strength to the Banks and Financial Institutions to expedite recovery of their dues but clever defaulters found their ways to move the Court / Debt Recovery Tribunal to delay the course of recovery and entangle the banks with endless litigation.


The appeals by borrowers under the SARFAESI Act lead to an immediate stay in the recovery process and stops banks from taking possession of assets of defaulters and selling them. The slow recovery mechanism by DRTs has contributed to the low ranking of India on the ease of doing business ratings. However, in order to address this issue, the government is working on a mechanism whereby debt recovery tribunals (DRTs) will hold only two hearings within a defined time period - one for the interim order and the other for the final order. With this, the banks may be able to make faster recoveries from defaulting borrowers. Further, the government has also asked the Department of Financial Services (DFS) to undertake computerization of all DRTs. The objective is to ensure that the filing of pleadings, the filings of documents, the filing of replies, is all done online with a provision of two hearings in a defined period of time.


c. Banks also sell their loans to Asset Reconstruction Companies (ARCs). The ARCS which are expected to play a pivotal role in recovering and reconstructing the non-performing assets (NPAs) are proving to be inadequate. The net worth of 15 operational ARCs in the country is only around Rs 4,000 crore whereas stressed assets in the system run into lakhs of crore rupees. ARCS are in dire need of incremental capital to be able to grow and play a useful role in the sector. Investors may be interested in the business, but are cautious on account of slow pace of judicial and administrative environment. One of the issues which ARCS face is around pricing of NPAs. Currently, the gap between price expectation of sellers and bid price by the ARCS is too wide to be bridged, which is also evident from the low success rate of auctions.


This also proves to be a hindrance while bringing in more investors willing to invest in the security receipts (or SRs) being issued by the securitization and reconstruction companies to raise funds for acquisition of NPAs. Discovery of fair price for NPAs may definitely help in more deals going through auctions and also generate interest from secondary investors like distress asset funds which can participate via securitization and reconstruction companies. Another issue is around discounts. Off late, the discount rate at which ARCs are acquiring NPAs from the banks and Fls has decreased considerably. On the recovery side, the performance is not very encouraging either. As on March 31, 2015, the average recovery rate (assets resolved as a per cent to assets acquired) of securitization and reconstruction companies was at 31 per cent.


According to the central bank, one of the reasons for a dip in the average recovery rate is due to the fact that substantial part of the assets under management of securitization and reconstruction companies is acquired recently. Then, there is the issue of the judicial process. An important factor affecting recovery performance of securitization and reconstruction companies, according to the RBI, is the delay in judicial process, be it under SARFAESI Act or at the level of debt recovery tribunals.


The Government and the RBI have been constantly working towards improving the banking sector in the country. Some of the work-in-progress initiatives include-I. 1) RBI is exploring the possibility of limiting the number of lenders in a consortium for better oversight of credit. In the prevailing scenario, Banks lend to large projects in a consortium, which is generally led by the one with the maximum exposure to the account. There have been cases of number of lenders in a single consortium going up to 18. Typically, banks prefer sanctioning big-ticket corporate loan in consortium format to diversify their risk emanating out of large exposure. However, if too many (consortium) members are there, credit monitoring becomes a problem. So that's why RBI is considering to limit the number of members in a consortium.


2) Proposed Bankruptcy reform - While realizing the importance of having a strong bankruptcy framework in improving the ease of doing business, the Centre had constituted a Bankruptcy Law Reforms Committee to study the corporate bankruptcy legal framework in India. Based on the report submitted by the committee early this year, the GOl recently published a proposal to overhaul an outdated and overburdened bankruptcy process with a unified bankruptcy code. The proposal had called for public comments and suggestions by Nov 19, after which the government will take a decision on the report and introduce it in parliament.


The proposed bill aims to significantly speed up decisions on whether to save or liquidate ailing companies, in a move to ensure higher recovery rates for creditors - both key to fostering a modern credit market and increased investment in India. Currently, lenders recover a paltry 20 percent of the value of debt in 4.3 years on an average. If adopted, the changes would bring in 'insolvency professionals' to run the resolution process, and set up creditor committees to reach a verdict on an ailing company's future in up to 180 days, removing government involvement and ending decades of judicial gridlock.


3) SEBI (Securities and Exchange Board of India) and the RBI have been working together on rules to help lower bank NPAs. Recently, SEBI changed the regulations to allow Indian banks to convert the debts of defaulting publicly traded borrowers into equity. SEBI and RBI are also considering new regulations covering willful defaulters" to impose restrictions on their ability to raise funds and make acquisitions. 4) Setting up of Public debt management agency (PDMA) - At present, RBI acts as the investment banker for the government and manages its debt. It is proposed to form and an independent debt management agency to manage government's borrowing in the future. In this regard, the government is planning to create a shell PDMA through an executive order in few months.


The shell PDMA will acquire the requisite skills by undertaking dummy trading in securities, working on new systems for primary issuance. The PDMA will also consolidate government debt data which is now scattered over RBI and several government agencies. The creation of the PDMA will enable RBI to focus on its core function of monetary policy and regulating banks. This agency is also expected to lower the government's borrowing costs eventually and foster a liquid and efficient G-Secs market. The idea is also to resolve the conflict of interests involved in RBI simultaneously targeting inflation by calibrating interest rates and regulating as well as managing government debt. After a year or so, PDMA would be handed over the advisory (middle office) and the job of issuance of government securities (front office function).


The government is also looking to implement some of the recommendations of PJ Nayak Committee on Governance in banks. The core of the recommendations in the PJ Nayak Committee report aims at reducing government control of public sector banks in order to improve governance. The committee has recommended the government to distance itself from several bank governance functions. For this purpose it recommends that the bank nationalization Acts of 1970 and 1980, together with the SBI Act and the SB (Subsidiary Banks) Act, be repealed, all banks be incorporated under the Companies Act, and a bank investment company (BIC) be constituted to which the government would transfer its holdings in banks. The government's powers should also be transferred to the BIC. It also suggested that the process of board appointments needed to be professionalized.


Appointments of CEOs, inside directors and top executives of public sector banks would be the responsibility of the Bank Boards Bureau constituting three serving or retired bank chairmen, and the government should not be involved in this decision in any way. Also, the committee has recommended proportionate voting rights to all shareholders and reduction of governmental shareholding to 40 percent.

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Date post:	21-Mar-2017
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Indian Banking Moving towards a new landscape - Regulatory Mechanisms - Part - 8

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