Are CDRs = NPAs? Financial Express 4th September 2012

The issue of restructured assets has come to the forefront at a time when the banking system is also under pressure with rising NPAs. An issue raised is whether or not restructuring is a euphemism for an NPA that is not classified as one. Or even if restructured assets are properly ‘identified’ and follow a well-defined classification, are there implications for the banking system?Corporate debt restructuring (CDR) became a controversial issue in the aftermath of the financial crisis in the US. During the crisis, it was difficult to judge the viability of a firm, and banks were jittery about the extent to which they could stretch their forbearance. However, post crisis, such restructuring was possible and banks were more confident of taking such decisions. However, here too it was critical to have the right judgement because through adverse selection or any attempt to protect the balance sheet to placate the markets, the malaise could get even more deep-rooted.In our own case, the rules have been laid down for CDRs as far back as in 2001 by RBI where consortium lending was the rule. The idea of CDR was that when companies are hit by extraneous circumstances that affect their performance and hence their ability to service their loans, there are credit-debtor agreements that are drawn up to restructure the debt in terms of tenure, swaps, interest rate and so on. This provides space for continuance of the company’s activity and the bank does not treat the loan as an NPA. There is a structured process for invoking CDRs, which ensures that there is transparency, and which limits the prevalence of arbitrariness.The growth in restructured assets has been 74% in the last three years, which is higher than the growth in credit that was around 66%. While the ratio of debt restructured to outstanding credit is low, at 3.3% as on March 2012, the elasticity of growth in debt restructured in response to growth in credit is increasing, which is a concern. It declined from 1.2% in FY10 to 0.3% in FY11 and increased to 2.1% in FY12 and further to 3.6% in June 2012. Quite clearly, while the overall level of debt being restructured is not of very significant dimensions in absolute terms, the fact that it has increased sharply in the last 15 months should make us pause and reflect. Also, given that over half of the restructured debt is in sectors such as iron and steel, infrastructure, textiles, telecom and construction, where the present prospects would probably be linked with those of the economy, these numbers could increase.While NPAs and CDRs are distinct concepts, their simultaneous growth over the years is significant. The ratio of incremental gross NPAs to incremental credit was 6.1% in FY12 while that for CDRs was 5.9%. Therefore, during the year, the ratio of the combination was 12% of increase in credit, which is quite high. As the economic environment would continue to be tenuous in the coming months, given the slowdown in industry and the uncertainty of policy direction, there could just be the tendency for these assets to increase. The fact that interest rates may not come down too soon would add to this feeling that the overall level of restructured assets would only move up in future. In fact, studies show that the corporate sector is now moving into the negative territory in terms of growth in profit with interest cover too decreasing, indicating stress on debt service.The CDR concept has, however, raised some controversy. The first is the treatment of such assets, which is a tricky issue. Once an asset is restructured and is out of the ambit of being a non-performer, it would get classified as a performing asset. But, what if it fails subsequently? Is there any recourse for the banking system as such, which would have proceeded on the basis of lower NPAs?Second, there has been a tendency for larger companies to have access to such a facility while the smaller ones are at a disadvantage. Is there uniform application of the process or does it tend to get discretionary?Third, there is need for some introspection on the reason for the emergence of such cases. Is it purely due to external factors or is it also a part of incorrect judgement on the part of the lending institution? This is important to ensure that banks are also more cautious when lending money.Fourth, while performance of CDRs has been satisfactory so far, should such restructuring be encouraged? This is so because there is a view that there is a very thin line between restructuring a debt and the ever-greening of a loan. There is hence a moralistic issue here.Given that some sectors such a real estate, aviation, power, mining, etc, would tend to be volatile in terms of performance in the next couple of years, can there be an objective formula to qualify for a CDR? Some thoughts may be put down here. First, we need to have a transparent set of prerequisites for qualifying for restructuring. Next, once a CDR is invoked, there has to be an observation period during which banks should probably not treat the asset as being standard and it should be only after this cooling period that it actually goes back on track. Last, in case of failure, there must be a clear mention of the same in the books. Such principles would be useful for an objective evaluation of this process to ensure that CDR does not become simply a tool for delaying the inevitable.