Thursday, July 11, 2019

NPA crisis: Why RBI’s new framework on bad loans is interesting Financial Express June 11 2019

When economists build theories, one is always quite amazed, because they are rich in ideas and content. In the last decade or so, behavioural economists have taken over the science to link outcomes with collective human behaviour, which has made theories more appetising. Richard Thaler won the Nobel Prize for the theory of ‘nudging’, which is what all players in the market experience. People can be nudged to take insurance cover or to invest in a pension fund to plan for retirement. Regulators also have their job cut out when rules are laid down for playing the game. At times, the players get out of control and it may not always be possible to force punitive action. But, the rules can be so framed that players can be ‘nudged’ to behave in a particular manner. It is against this background that one can view the recent circular of RBI on resolution of stressed assets.
The replacement of RBI February 12, 2018 circular on insolvency was long awaited and the new guidelines released on June 7, 2019 are interesting. The main bone of contention was the one-day default recognition and the forced resolution through IBC, in case a solution was not found in a time-bound manner. This was set aside by the Supreme Court which, now, is not a part of the process to be followed. This is good news for companies, which found themselves in a position of disadvantage when the February 12 circular was invoked. Banks, too, were not comfortable with the outcome even though the onus was not on them, as their books looked more vulnerable.
Now, one gets 30 days to review the default and draw up a resolution plan which could, at the limit, also mean considering insolvency, depending on what the lenders deem fit. Therefore, the time period has been extended and opens the door to finding a more agreeable solution. But this will get reported to the central repository so that everyone is in the loop regarding the status of the loan. A period of 180 days is given for the resolution process, failing which, the provisions that have to be made by all concerned banks increases by 20% and further by 15% in case 365 days pass. In the earlier dispensation, after 180 days, the IBC shadow loomed, where, at the extreme, the promoter could lose ownership of the company. Now, taking the company to IBC is an option, but not mandatory.
The inter-creditor agreement is important here, whereby 75% of the o/s facility by value and 60% of the lenders must agree on a resolution plan. In the earlier dispensation, 100% agreement was required, which was always a challenge. By lowering the majority required, the procedure becomes more doable. However, this will definitely tilt the bias towards the larger lenders, who would tend to take decisions on this issue, while the smaller players would be at a disadvantage and have less power to guide the final call. As this applies to not just commercial banks but also small banks and NBFC-SI, it will be interesting to see how this works. Usually, the smaller players are happy to go with the larger lenders as the onus is on the others to take a call. Therefore, this may not make a material difference at the end of the day.
The decision, now, has to be taken by the banks and not RBI. This is the fundamental shift in stance. How will this work? If banks think that the case has to be referred to the IBC, they would follow the earlier path. But in the past, banks were loath to drag companies to the IBC of their own volition, because it would mean taking haircuts that were not agreeable. Therefore, it made sense to kick the can and procrastinate, and the various channels that were available, like JLF, S4A, ARC, CDR, SDR etc., were routes that could be explored. This made the decision-making process much more difficult. It was always difficult to find a solution as the lender wanted the lowest haircut and the buyer the highest. This made attaining equilibrium difficult. The restructuring process had its set of idiosyncrasies, where the decision was taken by the lenders to ensure that the loan was not called an NPA. The tenures would be extended and the interest rates lowered to make it bearable, but in the process, it became hard to distinguish between ever-greening and genuine restructuring, as there was always a perverse incentive to keep the loan looking good through this avenue.
It is not quite sure as to how this will work out in the times to come. But, RBI has plugged this gap in a very innovative way, knowing completely well that escape clauses run the risk of slippage. A deterrent on the procrastination possibility has been the provisioning norm that could go up to 35% in case of a year passing. Therefore, there would be some incentive to actually have a resolution plan which works in place.
RBI does come out quite fairly in this process, for even though there is no force being deployed, the nudge has been provided through the provisioning route. As banks do have problems on capital, they probably have to look at the most efficient ways of moving towards a resolution. RBI has given the power to the banks to decide, but has put in the required caveats to ensure that they act in a proper manner and do not delay the decision making process. Hence, this appears to be a better way out, as banks can no longer sit back and let things take their course. By abolishing all earlier schemes for resolution, the doors have actually been closed and lenders have been forced to find a solution within the rules framed by the RBI for this purpose. As it is within the norms of central bank regulation, there can really be no objection. This nudge may be as good as the push that was earlier dominant in the approach.

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