Soon after Urjit Patel took over as Governor of the Reserve Bank of India (RBI) in September 2016, he met top officials of commercial banks. The purpose of the meeting, as bankers later explained, was to better understand what they felt was ailing the sector and what the regulator could do to improve it.
According to bankers who were part of that meeting, who spoke on the condition of anonymity, Patel listened intently to all the representations made. And bankers came away with the impression that Patel may be sympathetic to their concerns that the bad loan clean-up was moving too fast.
An asset quality review of the sector had been initiated by former Governor Raghuram Rajan between October and December 2015. With the RBI detecting unreported stress, banks were pushed to classify bad loans appropriately. Schemes like Strategic Debt Restructuring and the Scheme For Sustainable Structuring of Stressed Assets (S4A) had been introduced but each of them came with tough conditions to ensure no ever-greening of bad loans was possible.
As Rajan exited and Patel took over, bankers once again made a pitch for easier rules.
One demand put forward by bankers at the meeting with Patel was to allow restructuring under the S4A scheme even if half the debt was not serviceable with existing cash flows, said a senior official at a large public sector bank on the condition of anonymity.
Bankers were hopeful. But they were disappointed. On 10 November 2016, the S4A norms were revised without giving banks any significant leeway on the use of the scheme.
In the months since, Patel has been anything but soft on banks and the bad loan problem. Quite the contrary.
He has signed off on a hotly-debated plan under which the regulator has directed banks to refer specific accounts for insolvency. He has pushed for disclosure of any divergence in the assessment of bad loans between banks and the regulator. He is also supporting consolidation in the banking sector, taking the view that only the strong should survive.
We believe that the steps taken towards containing the stress on bank books are positive. There could be a debate about the timing of it, but it will surely help banks put the legacy stressed asset problem behind them in a proper manner. We should be able to see the positive after-effects in about 18 to 24 months.Saswata Guha, director, Fitch Ratings India Ltd
Necessary Evil Or Regulatory Overreach?
Not all of Patel’s decisions with regards to the banking sector have been universally welcome. Among the more controversial ones was the decision to have the RBI directly intervene in the resolution of bad loans.
In a circular dated 13 June, the RBI told banks that it had identified 12 accounts that must be referred for resolution under the Insolvency and Bankruptcy Code within a month.
The purists were uncomfortable. The regulator should not be involved in commercial decisions of banks, was the sentiment expressed by former RBI officials that BloombergQuint spoke with at the time. Although most acknowledged that the bad loan situation was acute and something was needed to break it.
Was RBI Intervention the Answer?
It’s too early to tell. Of the 12 accounts, 11 have been admitted for insolvency proceedings. The RBI has now put out a second list of accounts, which banks will have to refer for insolvency proceedings unless resolved by December.
While pushing resolution via the Bankruptcy Code, the RBI has also not eased up on ensuring bank balancesheets are bullet-proofed. Provisioning requirements set for accounts referred for insolvency are onerous. Banks have to set aside 50 percent against secured exposures to these accounts and 100 percent against unsecured exposures.
Banks are now struggling to meet these requirements.
“Most banks are currently short of the 50 percent provisioning need on the IBC exposure mandated, and indicated that they need additional provisions of 0.2-0.9 percent of loans,” said Credit Suisse in a report dated August 17.
Increased Scrutiny and Disclosures
The RBI has also taken a few small, but important, steps in trying to improve governance at banks.
In a notification dated 18 April, the central bank said that banks would be required to disclose the divergence between what the RBI identified as NPAs at the time of the annual review and what the bank announced in its audited financial results in financial year 2015-16.
Following this, private sector lenders Yes Bank, ICICI Bank and Axis Bank all announced large divergences. Stock markets reacted to disclosure of this divergence, forcing bank managements to explain themselves.
In April, the central bank also created a separate enforcement department. The idea, the RBI said in a press release, is to develop a “sound framework and process for enforcement action.” The department will monitor non-compliance by any bank when it comes to regulations laid down by the RBI. It will also protect customers against any adverse banking sector practices like unreasonable charges.
Only The Strong Should Survive
In an address earlier this month, Governor Patel said that the RBI is working with the government on coming up with a plan to recapitalise state-owned banks, which would include merger as an option.
Patel has been vocal about his support for public sector bank mergers for some time now. Speaking at an even in New York in April, the RBI Governor had said that consolidation in the public sector banking space would create fewer but healthier public sector banks.
The weaker banks are losing market share (and) that is a good thing...The stronger banks are gaining market share, which is a good thing, particularly the private sector banks. In a way, it is working; those who need to shrink are shrinking.Urjit Patel
In August, the government set up an alternative mechanism to approve bank mergers and is pushing for such consolidation.
While the RBI may support this, it will not prod banks to go and consolidate, said Guha of Fitch. That is the function of the government as the majority shareholder, and the management of respective banks.
“It (RBI) will also not create bottlenecks for merger proposals. What might happen is that the regulator will become an enabler of sorts to ensure that consolidation actually takes place,” Guha said.
The Problem Is Far From Over
Patel’s bank headache is, however, far from over.
At the end of the June quarter, bad loans of listed banks had surged to over Rs 8 lakh crore. New stress points from among small and medium enterprises and the farm sector have emerged. At the same time, the economy has slowed considerably. And credit demand remains weak as a consequence of the weak economy and the deleveraging process which is underway.
As Patel enters into the second year of his governorship, banking will need to remain at the top of his agenda.
The RBI acknowledged this in its annual report released last week.
“The progress in resolving the highly indebted corporates and improving the financial health of public sector banks (PSBs) is critical for restarting credit flows to the productive sectors, apart from reviving the investment climate in general,” said the report in its assessment of the economy.
(This article was originally published on BloombergQuint)
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