Stressed Accounts Management & Financial Stability

“If you owe your Bank manager a thousand pounds, you are at his mercy. If you owe him a million pounds, he is at your mercy”.

J. M. Keynes

Stressed Accounts Management is actually a misnomer. The actual process of managing an account to avoid stress and future deterioration begins right from the very selection of the borrower itself. Simply managing a stressed account, after  identification of stress, is nothing but post  facto fire – fighting which can  be avoided to a great extent by due diligent and an analytical approach at the selection stage.

JOURNEY OF NPA MANAGEMENT:

In  order  to  promote  a  healthy  platform  and  enable the objective categorization of asset quality in banks, the Reserve Bank of India introduced the Income Recognition  and   Asset   Classification  (IRAC)  norms in the early nineties.   Transparency in disclosing the asset quality would eventually benefit stakeholders, like shareholders, depositors, regulators, etc. This has also drawn the attention of the banks towards emphasizing on monitoring of asset quality on an ongoing basis. Currently,  the  banking  and  financial  services  industry is struggling under the pressure of the corporate loan

‘crisis’, as the number of Non-Berforming Assets (NPAs) in this sector continue to soar. A close scrutiny of the loan sanctioning, disbursement and recovery process have  uncovered a  number of gaps and  inefficiencies. This includes identification and reporting  of NPAs. Regulators have taken a note of it and are suggesting a number of steps to tackle this economic debacle. On the other hand, early identification, correct  classification and  reporting  of NPAs require  greater focus  and improvement.

Regulators are increasing their efforts in curbing the alarming rate of growth in stressed assets. However, one of the less talked about issues here is that how these assets are currently monitored and reported. Banks have their own systems and processes in place for  the  identification   of  NPAs  and   provisioning.   The matter for concern is, how foolproof are the systems with respect to allowing possible manipulations and manual interventions while classifying  NPAs category.

The key issues that banks are facing today are in the nature of complexities around different systems used for NPA identification  and  provisioning,  over  dependence on third parties for technology support, lack of audit trails  to  identify  changes affecting  NPA  classification, lack of training and awareness at remote branches, etc.

The history of classification of stress accounts: 

• Until mid-eighties, management of NPAs was left to the banks and the auditors.
• In 1985,  the  first ever  system for classification of assets in the Indian Banking system was introduced on the recommendations of A. Ghosh Committee on Final Accounts. This system, called the “Health Code    System”    (HCS)   involved   classification  of loan accounts into eight categories ranging from 1 (satisfactory) to 8 (bad and doubtful debt).
• In   1991,   the   Narasimham   Committee   on   the financial    system  felt   that    the    classification   of assets, according to the HCS was not in line with international standards. It was suggested that for the purpose of provisioning, banks should classify their advances into four broad  groups. viz. (i) standard assets; (ii) substandard assets; (iii) doubtful assets; (iv) loss assets.
• Following   this,    prudential    norms    on   income recognition, asset   classification and   provisioning were introduced in 1992, in a phased manner.
• In 1998, the Narasimham Committee on Banking Sector Reforms recommended the further tightening of prudential standards in order to strengthen the prevailing norms and bring them at par with evolving international best practices.
• With the introduction of 90-days norms for classification of NPAs in 2001,  the  NPA guidelines were brought at par with international standards.

MANAGING STRESSED ACCOUNTS:

1.   Prevention of potential stressed accounts.

This involves right selection of borrowers at the initial stage. The  primary  reason for  high  NPAs  in  Banks is the simple fact that, instead of going to the market and selecting good customers, most of the Banks are depending on a few walk in customers or customers brought in by unscrupulous Consultants. The choices here are limited and the possibility of fraud and misappropriation is high. Most of the corporate customers are referred to the Banks by merchant bankers and loan syndicators instead of the Banks identifying ‘A’ rated borrowers  themselves  and  formulating  strategies  to get a share in their business. In fact, most of the banks do not have a robust credit marketing system. This could address the issue of unhealthy exposure in the beginning itself.

This gap can be bridged to a certain extent by proper due diligence about the genuineness of the borrower, his track record and the genuineness of his intent based on market  inquiry and  verification of the various  reports and records available in the public domain.

Analysis of technical and economic viability of the project is very important.  This requires a significant  amount of technical skills. In many cases, the obtaining of a TEV study report is entrusted directly to the borrower without realizing that he can manipulate the report.   Another area of expertise is the correct assessment of fund requirement, cash flow and marketability  of the product. 

The following are some of the issues which call for careful examination. 

a) The realistic level of sales based on past performance / industry outlook

b) The utilization of capacity

c) The break  even  period and volume 

d) The requirement funds

e)  Cash flow based on  the  sales and  its adequacy  to meet the repayment obligations. 

Many of the projects are failing due to improper assessment of cash flow, fixing of repayments  which do not match with generation of cash and time/ cost overrun leading to the debt mounting to unsustainable levels.

The next area requiring focus is to ensure that the assets are created and funds are not diverted elsewhere. This should not end at the installation phase, but continue on a continuous basis.   Such monitoring will ensure that not only the term loan component, but even the working capital is also not diverted. Hence Credit Monitoring during   Pre-disbursement;  during   disbursement  and post disbursement is very critical in maintenance of asset quality. Disproportionate blocking of funds in receivables and not routing the transactions through the account should not be allowed. This will also prevent any possible diversion of funds.

2. Initiating timely action upon identifying stress

Once  stress is detected in an account, the first thing one must do is to assess the triggers of stress. It could be any of the following reasons.

a)   Due to diversion  of funds 

b)   Low market  demand

c)   Blocking  funds  in receivables (In conducive to the business profile)

d)   Slow picking up of sales

e)   Using working capital for long term investments 

f)    Other reasons,

(1) On-site Internal Signals.

• Non – compliance with the terms  of sanction. 
• Unplanned borrowing for margin contribution.
• Delay in payment of interest.
• Installment overdue beyond 30 days.
• Return  of cheques for financial reasons.
• Reduction in credit summations – not routing entire(or prorata) transactions through  the Bank, Opening of collection accounts with another Bank without prior approval of appropriate authority.
• Longer outstanding in the bills purchased accounts.
• Longer  period  of credit allowed  on sales, Bills negotiated through the bank outstanding after due dates, frequent return of Bills and late or non- realization of receivables.
• Constant utilization of working capital limits to the brim.
• Unexplained delay or failure to submit periodical statements such as stock / book debts statements, MSOD,  CMA,  QPR,   balance sheets  etc.   /  other papers needed for review of account.
• Frequent  requests  for  excess/  additional  limit  or for extension of time for repayment of interest / installments.
• Adhoc/excess/Bill purchase  overdue, LC devolvement / Guarantee invocation.
•  Lack of transparency in borrower’s  dealings with the Bank / avoiding meeting bank officials.
•  Constant failure or unwillingness to mention unpaid stock in stock statements or age of book debts in book debt statement.

(2) Off-site External Signs

• Delay in project implementation.
• Installation    of   sub    –   standard    machinery   or machinery not as per the project report / approved quotations.
• Frequent break down in plant / machinery.
• Production  noticeably  below   projected  level   of capacity utilization.
• Labour    problem    and    frequent   interruptions   in manufacturing.
• Non  –  availability  of  vital  spare  parts/major raw material.
• Production of unplanned items  without reporting  to the Bank.
• Disposal / replacement of vital plant and machinery without Bank’s knowledge.
• Downward trend in sales.
• Higher rate of rejection  at process stage / final stage / after sales.
• Delay or failure to pay statutory dues.
• Abnormal increase in debtors and creditors.
• Increase in inventory, which may include large quantity of slow and non- moving items.
• General decline in the particular industry combined with many failures.
• Rapid turnover of key personnel.
• Filing of law suits against the company by its customers, creditors, employees etc.
• Unjustified   rapid   expansion  within  a   short   time without appropriate financial tie up.
• Sudden  /  frequent  changes  in  Management  /infighting within the management.
• Reduction in profit / unit starts incurring losses.
• Dependence on single or few buyers / no alternate market for product.
• Threat of action against the borrower from statutory bodies e.g.  Pollution control, Labour  Welfare  Dept., Income Tax / Sales Tax / Octroi / Excise / Customs Dept. etc.
• Poor or dubious record  maintenance.
• Speculative  inventory acquisition  not  in  line  with normal purchasing practices.
• Poor maintenance of plant / machinery.
• Adverse market reports on the borrower / concern.
• Loss of crucial customers.

Once the account is under stress corrective action is to be initiated immediately or else it will result in the mounting of interest and the debt reaching unsustainable levels.The  required  corrective  action  will  be  different      in each  case.  Say  for  example,  if  diversion  of  funds is established, the borrower should either bring the diverted funds back along with the margin or else legal action should be initiated immediately.

In case  the  issue is of low  market  demand  for  the manufactured  product  and  there  being  no  provision for switching over to an alternate product, it is better to prepare ground for exit in the initial stage itself. It is

observed that many new generation banks make an early exit in such cases, by compelling the borrower to leave by raising the rate of interest or stipulating new terms & conditions. Though re-scheduling is an option in case of ‘c’ and ‘d’ above, it is always better to create ground for exit or impress upon the borrower to bring additional capital or a strategic investor.

In case of ‘e’, even though it is an irregularity on the part of the borrower, the issue can be addressed by reimbursement  of  capital  /  long  term  expenditure; if the working capital funds are genuinely utilized / diversified  for creation of assets like plant & machinery or equipment needed to run enhance the problem or by way of extending the required working capital if the increased capacity can be productively used to increase production and sale.

Where the market and industry conditions are not conducive, borrowers and lenders can resort to bringing down the debt to a sustainable level by selling off the noncore assets or  inviting investors for a stake in the company  by  converting the  unsustainable  portion  of debt into equity.

Change of Management outside SDR can also be thought of as a good strategy for management of stressed assets  /NPAs.  Banks   can   also   explore   the option of converting a part of the debt into equity through SDR route. This can be off loaded within 18 months and Bank can retain the IRAC status till then, at the same time working out alternate plans for a change in the management of the unit.

Even, as per latest RBI guidelines issued on 25th February 2016, fraud accounts can also be restructured with dispensation of keeping the account as standard; provided change of Management happens. The idea is that it’s not the business commits fraud, its promoter/ person who commits fraud.

The new scheme of S4A is also more or less on the same lines of separating sustainable from unsustainable debt and can be explored in such cases.

(3)  Revival   strategies   are   not   viable,   initiate recovery proceedings.

Banks can initiate SARFAESI action and take required steps in a time bound manner. Wherever the borrower is likely to go for a stay order from caveat be filed.  Wide publicity be given for auctions. Uncharged assets to be identified and attached through court   by  filing  ABJ  (Attachment  Before   Judgement) along with the Original Application with DRT.

Declaring the borrower as a wilful Defaulter and a Non Cooperative Borrower will stop the company or promoters or other companies of the promoters from availing credit facilities from any other  financial institution. 

Publishing  photograph of defaulters will put pressure on the borrowers/ guarantors. In case of companies, filing of winding up petition  can be thought of. The option of the attachment of debts of the company and getting a garnishee order can be explored.Filing case under section138 of Negotiable Instruments Act if a cheque given by the borrower has bounced. Each  file is to be studied minutely in order to understand what kind of action is required in a particular case.

CAUSES:

1.   Fundamental Reasons :

The first important reason is the lack of due diligence, post sanction inspections, monitoring and audit alongside a weak governance mechanism to check corrupt practices and political interference. This often leads to the diversion of funds into creations of personal assets.

2.   Corporate Imprudence:

The imprudence of the corporates can be considered to be the second most important factor for poor asset quality in the system. Some of the major failings that the corporates exhibit are:

• Overleverage - All debt, no equity. Veiled and complex corporate structures impede assessment by banks.
• Obsession for higher growth- Excess capacities, unrelated diversification. The liquidity generated due to ultra-accommodative monetary policy stance by Central Banks in advanced economies also created misaligned incentives.
• Chasing profits- Ignoring risks inherent in unhedged forex exposures.

3.   Corporate Misdemeanors

Not all promoters have a same inner voice and some of them are out to hoodwink the system. They are hardheaded defaulters in banks' books as they have been unwilling to respect their repayment commitments,

even while having an ability to do so. A section of the promoters have redirected funds for purposes other than for which the money was granted. There are similar events where a section of the borrowers have redirected reserves for individual extravagance and indulgence and not created any gainful asset. Some promoters have disposed of assets created out of Banks funds without the information of the Bank. The resulting defaults are intentional and hence wilful.

The mistakes of the banks and corporates, whether coincidental or purposeful, have brought about a gigantic heap up of non-performing assets in the Banking industry. While the banks were expected to prevent credit risk concentration, particularly in areas, with unreasonably high risk, the corporates should have had better understanding of the emerging market.

4.   The Environment factors:

The economic downturn, since the Financial Crisis in 2008,  can  be considered one  of the significant  reasons for the Asset Quality issues in India. There are other issues as well, like fall in prices, dumping by China and so forth which has impacted competition and resulted in the creation of idle assets. The policy logjam added fuel to the fire. The growth in large scale ventures in the nation have remained slowed down because of absence of clearances, cancellation of coal blocks, falling through of the fuel supply, etc.

Such promoters can't be termed as willful defaulters or such  lenders can't be called to have  malafide  intentions, but it sure  leads to financial  instability. While we battle to address these issues, the priority is in focusing on remedial measures;

The Remedial Measures

The deterioration in the asset quality in India for the first time has  been influenced powerfully by the  global factors. This is the reason that the simple strategies of re scheduling the loan, acquiring assets through SARFAESI act or settling dues through DRT, is proving to be inadequate. CDR is mostly useful when the industry or  the   borrowal   account  is  influenced  by  domestic cyclical factors of Indian economy. But when the impact of global factors start playing and economic revival gets linked to Global factors the models of recovery and paradigm of life cycle of Borrowal accounts undergoes changes .The hesitation to declare  different stages of a disease has to change. We as people need to bravely

declare particularly when the critical care is called for, or when there is a multiple organ failure or when the patient  is  dead.                            As the new  paradigm  emerges,  a patient is shown under several categories beginning from mild illness, curable through medicines or patient needing surgery or patient to be declared incurable or finally dead.

The model of recovery which was personal contacts, demand notices or filing a debt  recovery suit has  been changing continuously over the last 50 years or so in order to keep pace with changing times. DRT Act of 1993 gave special teeth to Bankers when Banks were getting exposed to the impact of liberalization on lending and recovery. SARFAESI Act of 2002 brought a revolutionary change as lengthy court procedures gave way to notice, possession and auction sale of assets both primary or collateral.   CDR was a more sophisticated version to meet the cyclical misfortunes of any corporate owing to domestic factors. SDR is a great step forward as it aims to eliminate non serious players from the market who probably could not bring the proper management practices. SDR takes the next step of taking a partial ownership and management control, run to revive the stressed assets and finally find a new owner to manage the company and  its assets. And finally the SDR which takes care of all listed companies moves to S4A to focus exclusively on companies having extraordinarily high exposures from institutional lenders beyond a threshold of Rs 500 crore.

Since companies with such high exposures impact the financial stability of the national  economy, sustainability factor is taken  into account. And finally, when the patient is beyond a cure, insolvency and Bankruptcy is resorted to  protect  the  surviving  organs,  protect  them  from further decay, keeping the possibility of utilizing them productively by organ transplantation approach.

1.   Financial Re-engineering

Financial  re-engineering is a multidisciplinary field involving economic theory, statistics, the methods of engineering,  tools  of  mathematics  and  the  practice of programming. The key objectives of financial re- engineering are facilitation of the new budget framework, identification,  review  and  improvement of key  process control, improve the efficiency and accuracy of financial data capturing, changing products, systems, people, brands  technically, improving in  availability and accessibility  of  financial   reporting,   decision  making

and risk management and continuous improvement. Financial reengineering plays a key role in the customer driven             derivatives    business   which    encompasses quantitative modeling and programming, trading and risk management, derivative products in compliance with the regulations and Capital /Liquidity requirements. These things look very complicated or to use Indian proverbial saying “Theoretical”. As the Indian economy gets more and more intertwined with global economy, predictability has to be based upon certain models and theories as gut feelings of Indian businessmen may not be adequate to read the global trends.

2.   Joint Venture Fund (JVF)

Recently SBI and a Canadian firm, Brookfield Asset Management Co  have proposed to launch a joint venture fund to which the Canadian partner  would commit Rs 7000 crore to purchase the distressed assets .SBI would contribute 5% of the investments.

3.   Insolvency and Bankruptcy Code 2016

The insolvency and bankruptcy code 2016 will establish some very basic principles of doing business in India. The focus is on quick decision making, be it turn around or liquidation, apart from the early settlement of all stakeholders. Indian promoters have always believed or perceived their right over their business as if it were their divine right, as they were protected by multiple laws and Indian courts. Courts were driven by a concern that in case, insolvency and bankruptcy were to be declared, the resultant closure of any business would mean a heavy loss of livelihood or employment to hundreds of families. The new code snatches away this right of promoters over their business perceived all along these years. But I would request you to appreciate this from the angle  of financial stability, as there  are more than 5000 cases of insolvency locked up in the Indian courts for years or for decades.

The most  significant  provision of the codes is the water fall mechanism – Liquidation will be paid in the following sequential manner; Secured creditors, Workmen dues for 12 months, Employees other than the workmen, Unsecured creditors. Government dues have been put in the last. The code protects the interest of operational creditor also besides Banks.

The   code   will  open   floodgates  of  requirement  for insolvency    professionals    capable    of    objectively assessing business and able to turn around, or liquidate them with a governance framework with minimum court intervention. Once the legislation comes into force new standards of professionalism to match global trends may come up in the natural course. These professionals might be required to shoulder accountability with penal provisions for negligence.

Strengthening asset quality is the second phase of transformation agenda.  The  finance  ministry  and  RBI had  been working  on  the  asset quality  review  (AQR) envisaging that the  stressed assets should be stabilized by March 2017.

Therefore   the   perceived   feeling   of   some   of   the Indian Businessmen that all this happened due to an overzealous  or  premature  initiative  of  the  regulator is quite ill placed. It was agreed to between Banks, Government and RBI to consciously move in this direction. Therefore, with this mandate, RBI wants to complete the cleanup of bad loans through AQR by March 2017, and most banks have reported a sharp drop in their profits or posted losses because of higher provisioning to cover potential losses.

4.   Central    Repository  of  Information  on  Large Credits (CRILC)

To address the problem early, a Central Repository of Information  on  Large  Credits  (CRILC) to collect,  store and disseminate credit data to lenders, has been set up.    Under  this  arrangement,  banks  are  reporting credit information,  including classification of an account as SMA  to  CRILC  on  all  their  borrowers having   an aggregate fund-based and non-fund based exposure of Rs. 5 crore and above to RBI.

As soon as an account is reported by any of the lenders to  CRILC  as SMA-2,  they  should  mandatorily form  a committee to be called Joint Lenders’ Forum (JLF) if the aggregate exposure (AE)   (fund  based and  non-fund based taken  together) of lenders in that account is Rs.

1000  million and  above. Lenders also  have  the  option of forming  a  JLF  even  when  the  AE in an  account is less than Rs. 1000 million and/or when the account is reported as SMA-0 or SMA-1.

5.   Structuring of the credit facilities extended to various borrowers:

Setting realistic repayment schedules on the basis of a proper  analysis of cash flows of the borrowers. This would go a long way to facilitate prompt repayment by the borrowers and thus improve the record  of recovery in advances.  A ‘one size  fits all’ approach and providing plain vanilla loans to all clients may not be in the interest of banks as well as its customers.

6.    Flexible Structuring of long term project loans with periodic refinancing option (known as 5:25 scheme) In order  to effect  a  structural change in the way project loans are granted by banks, and considering the need to facilitate banks to offer long term project financing,  which may ensure long term viability of infrastructure and core industry sector projects by smoothening the cash flow stress in the initial years of such projects. Reserve Bank of India has issued guidelines on Flexible Restructuring.

7.    Restructure / Rehabilitation

Despite   proper    credit    appraisal    and    proper structuring of loans, slippages in the asset quality may not be unavoidable, especially when the economic cycles turn worse. Hence, once a weak account is  identified,  one  of the  remedial options is restructuring.   Inspite, of their best efforts and intentions, sometimes borrowers find themselves in financial  difficulty because of factors  beyond their control and also due to certain internal reasons. For the revival of the viable entities as well as for the safety of the money lent by the banks, timely support through restructuring in genuine cases is called for. The objective of restructuring  is  to  preserve  the economic value of viable entities that are affected by certain internal and external factors and minimize the losses to the creditors and other stakeholders.

RBI’s prudential guidelines on restructuring of advances lay down detailed methodology and norms for restructuring of advances under sole banking as well as multiple / consortium arrangements.

8.   Corporate Debt Restructuring (CDR) mechanism is an institutional framework for restructuring of multiple  /  consortium  advances  of  banks  where even creditors who are not part of CDR system can join by signing transaction to transaction based agreements.

Mere classification of an account as non-performing asset need not result in withdrawal of support to viable borrowal accounts.   The purpose of asset classification  and   provisioning    is   to   present a true picture of bank’s balance sheet and not to stigmatize accounts / borrowers.   However, while considering their support to accounts under stress, proper distinction between wilful defaulters / non- cooperative / unscrupulous borrowers on the one hand, and on the other hand, borrowers defaulting on their debt obligations due to circumstances beyond their control should be made.

9.   Strategic Debt Restructuring (SDR) Scheme

The  Strategic Debt  Restructuring (SDR)  has  been introduced  with  a  view  to  ensuring  more  stake of promoters in reviving stressed accounts and providing banks with enhanced capabilities to initiate change of ownership, where necessary, in accounts which fail to achieve the agreed critical conditions and viability milestones. SDR is about taking control of distressed listed companies with an objective to initiate change of management of companies, which fail to achieve the milestones under corporate debt restructuring.

SDR is subsequent to CDR or any other restructuring exercise undertaken by the companies. The consortium of lenders in case of SDR is known as Joint Lenders Forum or JLF, which is empowered to convert the entire or part of the loan, including the unpaid interest into equity shares, if the company fails to acquire the milestones and critical conditions stipulated in the restructuring package.

The  JLF  has  to evoke  the  SDR  within 30  days  of review  of account and  JLF must  approve the  debt to  equity  conversion  within  90  days  of  deciding to  invoke  SDR.  The  JLF  gets   further  90  days   to actually convert loan into shares. On completion of conversion of debt to equity & take over minimum

51% by lenders within 210 days from date of review, JLF shall hold the existing assets status for another/ total 18 months provided   at least 26% is taken/ purchased by  a  new  promoter(out of  51%  which lenders took over within 210 days  of date  of review) and  thereafter divert  their  remaining(25%) holding to another promoters following which the loan will be upgraded to “STANDARD”(if the account is NPA on the  date  of reference). The  new  promoters should not be a person entity from the existing promoters / promoters group.

10.  Joint Lenders’ Forum Empowered Group (JLF – EG)

JLF  will finalize  the  Corrective Action  Plan  (CAP) and the same will be placed before an Empowered Group   (EG)  of  lenders,  which  will be  tasked  to approve the  rectification  /  restructuring packages under  CAPs.

The  decision on  the  CAP  must  be  approved by a minimum of 75% of creditors by value and 60% of creditors by number in the  JLF.   After a review, the proportion of lenders by number, required for approving the CAP has  been reduced to 50%.   The top two banks in the systems in terms of advances, namely SBI and ICICI Bank, will be permanent members of JLF EG, irrespective of whether or not they are lenders in the particular  JLF.

11. Scheme for Sustainable Structuring of Stressed Assets: (S-4A)

Reserve   Bank,   has   formulated   the   “Scheme for Sustainable Structuring of Stressed Assets” (S4A)  as an  optional  framework  for the  resolution of large stressed accounts.   The S4A envisages determination of the sustainable debt level for a stressed borrower, and bifurcation of the outstanding debt into sustainable debt and equity / quasi-equity instruments which are expected to  provide upside to the lenders when the borrowers turns around.

A debt  level will be deemed sustainable if the Joint Lenders Forum  (JLF) Consortium of lenders / bank conclude through independent techno-economic viability (TEV) that debt  of that principal value amongst the current funded / non-funded liabilities owed to institutional lenders can be serviced over the same tenor as that of the existing facilities even if the future cash flows remain  at their current  levels.

To sum up, management of Stressed Accounts Portfolio  is  an  ongoing   process starting   from  the selection of the borrower till the settlement of the account.  Stronger the foundation, i.e. the selection of the borrower, lesser will be the subsequent stress and efforts required to manage the portfolio.

FINANCIAL STABILITY:

Financial stability is a prerequisite for the kind of growth we dream of from the sweet spot where India is today. Effective  and   efficient  use   of  the  tools available  for clean-up, in the most expeditious manner, is the need of the moment.

The Government and the RBI have embarked upon programmes for  containing  inflation to tolerable levels, employment generation through big thrust on manufacturing  enterprises,  and  accelerate  pace  of GDP growth. De-clogging  and cleaning up the financing channels have brought us to several initiatives from DRT to S4A mechanisms and Bankruptcy Code which are mainly targeted at large corporates and big accounts which account for major chunk of stressed assets of all Banks.

Banks  play a vital role in providing financial  resources, especially  to capital-intensive sectors such  as infrastructure, automobiles, iron and steel, industrials and high-growth sectors such as pharmaceuticals, healthcare and consumer expenses. In emerging economies, banks are more than mere agents of financial intermediation  and  carry  the  additional  responsibility of achieving the government’s social agenda also. Because  of  this  close  relationship  between  banking and economic development, the growth of the overall economy is intrinsically correlated with the health of the banking industry.

The large amount of stressed Assets in the Banking System had resulted in the slowdown in Credit Growth due to the absence of any fresh funding by the Banks which have directly affected employment opportunities and affected production and thereby leading to fall in the National  Income.  In a  country  like India,  where  Public Sector Banks play a vital role in the development of key sectors, the increase in the Stressed Assets have dried up the resources leading to absence of any major lending  activity which tells upon  the financial stability of the Nation.

The build-up of stressed loans has led to a slowdown in public sector bank lending in certain sectors. High distressed exposures in such sectors were already occupying Public  sector Bank’s  attention and  holding them back. The only way for them to fulfill the economy’s credit needs, which is essential for economic growth, is to clean up and recapitalize.

Of late, in an attempt to reduce the size of stressed assets in an already expanded balance sheet, Banks have not been lending much and this bodes well for future slippages too. When it comes to choosing between clean up or growth the answer is unambiguously “Clean  up!”. Rather, this is the lesson that every other country, which has  faced  such  financial stress has  on offer.

The Government is in the process of speeding up Debt Recovery and has already created a new Bankruptcy Code.  This  is  an  important  step  towards  improving the resolution process. In the near term, however, the following action will pay large dividends. That is to improve the governance of public sector banks so that they are not faced with such a situation in future. The Government, through the Indradhanush initiative, has sent a clear signal that it wants to make sure that public sector, once healthy, stay healthy.

Conclusion and Future Outlook

Post  AQR, challenges abound, even  if the  Bankruptcy code is implemented.   Corporates to a great extent are  overleveraged with extremely impaired  cash flows. These corporates require capital, new administration and new promoters. Banks are hesitant in increasing their exposures in stressed assets for a number of reasons. It might be very difficult to run unit profitability without bringing down the burden of debt on the corporate. Therefore the  first step   would  be  to  bring down the debt exposure to a reasonable level. This may include writing down a part of the debt obligation by the lenders and/or converting a part of the debt into equity and get another promoter to run the undertaking. This may, nonetheless, be a time consuming and lengthy process and consequently, in the meantime the banks may need to designate an O and M operator to run the operations. In specific  cases, there  might be a need for some additional funding for investment or for working capital needs. A major obstacle that one comes across, in the  working of the  JLF is lack of consensus or slow advancement of consensus among the members of the consortium as also lack of authority at Branch level and, therefore, the resultant action by the unit keeps getting delayed. The delay somehow defeats the very purpose for which the JLF mechanism is set  up.

There are some views about setting up an investment fund which might come in as a last mile lender. The investment fund could lend to the truncated enterprise and  help it get back  to profitability at which level banks could  profitably dilute  their  equity  holdings  in the  firm. Question  is  who  would  fund  this  investment  fund? The recent in principle agreement between SBI and Brookfield  Asset   Management  co  to  launch   a   joint venture fund could be forerunner to many such ventures of future.

The global economy has been passing through a difficult phase and the vulnerabilities still remain. Against this backdrop and that in a globally integrated economy, a general decline in the asset quality was not totally unexpected.  However,  the  extent  being  witnessed could have been avoided. It is probably because neither the banks nor the corporates resorted to preventive healthcare.

Amidst the continued global slowdown, the prospect of domestic growth remains positive for 2016-17 mainly on account of various monetary and non-monetary reforms undertaken, expectations of a normal monsoon, easing of CPI  inflation and  rising private  consumption. Focus on rural and social infrastructure sector and decline in subsidy outflow have  resulted in improvements in the fiscal  front,  both  quantitatively and  qualitatively.  One can expect that everyone would emerge much wiser after enduring the pain and be judicious in the approach and get a periodic check-up done so that they can stay healthy and live longer.

The pivots of macro-economic indicator of any economy, namely   growth,  inflation  and   employment shape  the economic outlook. Individual improvement on these three  pivots  will have  significant  bearing on taking  out any economy from economic stress which will in turn have  impact  on financial  stress being  observed in that particular economy.

The  two traditional constituents   of   growth    i.e. manufacturing and agriculture has substantial linkages to the  pivots  of economic growth.  GDP  growth  coming from manufacturing and agriculture will result into de- stressing the financial sector by turning non-performing assets into  performing  which  will further  add  to  GDP growth.    Lower  inflation  always   helps   in keeping the interest rate capped and thereby supporting both manufacturing  &  agriculture  which  will  again  add to  growth  besides  credit  employment. Therefore, improvement in economic stress will automatically lead to distressing of financial sector.

Courtesy: Dr. R. C. Lodha (Executive Director, Central Bank of India)