Amid crisis in banking, fresh risk for the RBI

The banks, especially nationalised ones, in India have been in a perpetual state of crisis.

In any economy, the banking system is the steel frame that holds it all together. Banks can go bust when depositors withdraw money in panic, or when the companies or people to whom they give loans are unable to return them. The system is in crisis when the bad loans equal or exceed the capital of the banks. It is saved only when governments bail out the banks by putting in more money to “recapitsalise” them. The banks, especially nationalised ones, in India have been in a perpetual state of crisis. The bankers on instructions (a phone call) from powerful politicians extend loans to dodgy promoters. The rot starts with top appointments that are made in deals in which both top managers and their political bosses share the cut. The practice has been going on for so long that, it became part of business lore, until RBI Guv Raghuram Rajan clamped down, The crucial factors are the percentage of loans that are “non-performing”, the infusion of public money needed to save the banks, the pressure that can be put on promoters to return the money, and the effect of all this on the economy. The June 2016 Financial Stability Report (FSR) brought out by the RBI quantifies the crisis.

This was because the gross non-performing advances (GNPAs) of banks “sharply increased to 7.6 per cent of gross advances from 5.1 per cent between September 2015 and March 2016.” Besides this, the banking sector’s GNPAs showed a sharp increase year-on-year of 80 per cent despite the low growth of credit. The growth of bad loans was not evenly distributed. It is the large borrowers who do not pay back. The ratio of bad loans of large borrowers increased sharply from 7.0 per cent to 10.6 per cent during September 2015 to March 2016. Moreover, “there was a sharp increase in the share of GNPAs of top 100 large borrowers from 3.4 per cent in September 2015 to 22.3 per cent in March 2016.” The crisis in the banking system is thus largely a result of the big borrowers’ inability or unwillingness to pay. One recalls the ever-flamboyant Vijay Mallya, who did not settle his dues to the banks and took refuge in the UK.

The debt owed by some of the biggest companies in the power, transport and steel sectors made for compelling reading in a report “The House of Debt” by merchant banker Credit Suisse. The report mentioned 10 top debtors. The total debt of these 10 groups was Rs 7.32 lakh crore (or trillion). The debt of these groups has risen seven times over the past eight years and some of these groups are carrying an interest burden that exceeds their earnings before interest and taxes. Not all these loans are bad, and many of these business groups are selling part of their assets to reduce their debt. Still, around Rs 4 trillion will be needed by the government if it is to recapitalise the banks. The pumping of money into banks comes from the government’s budget expenditure.

India Weekly Market Updates from 2nd July to 8th July 2016

India Market Weekly Economy: Government is expected to go ahead with the strategic divestment in public sector units (PSUs) within the next six months besides closing down sick firms that are beyond revival, NITI Aayog Vice Chairman Arvind Panagariya said. Britain will start trade talks with India for a bilateral deal as it redraws economic ties with the world after being forced by a referendum vote to leave the EU The total sown area as on 8th July, 2016 as per reports received from States, stands at 406.27 lakh hectare as compared to 431.82 lakh hectare at this time last year. (PIB) The water storage available in 91 major reservoirs of the country for the week ending on July 06, 2016 was 28.208 BCM, which is 18% of total storage capacity of these reservoirs.  This was 55% of the storage of corresponding period of last year and 74% of storage of average of last ten years. The Union Cabinet has approved the Interest Subvention Scheme for farmers for the year 2016-17. The Government has earmarked a sum of Rs. 18,276 Crore for this purpose. This will help farmers getting short term crop loan payable within one year up to Rs. 3 lakhs at only 4% per annum. The Union Cabinet has given its 'in-principle' approval for setting up a Major port at Enayam near Colachel in Tamil Nadu.  A SPV will be formed for development of this Port with initial equity investment from the three Major Ports in Tamil Nadu i.e. V.O.Chidambaranar Port Trust, Chennai Port Trust, and Kamarajar Port Limited. Exports of gems and jewellery grew 25.5 per cent to USD 5.78 billion during the first two months of the current fiscal, largely driven by demand in India''s major markets like the US. India witnessed the fastest domestic air passenger growth at 18.8 per cent in 2015, way ahead of neighbouring China and the United States, according to IATA. Delhi-NCR has recorded 39% increase in net office space absorption at 2.4 million sq ft in the first half of this year on the back of a few large-sized leasing transactions, according to property consultant Cushman & Wakefield. Gold imports fell by about 51 per cent to USD 2.7 billion in April-May this fiscal, which is expected to keep a lid on the current account deficit.  India's tea output declined by 15 per cent to 67.21 million kg in April this year, mainly due to fall in production in southern states.  MRP of DAP and MOP fertilizers to come down with immediate effect; Enough availability of all the required fertilizers in the country, said the Minister of Chemicals and Fertilizers Raising concerns over jobless economic growth, Bajaj Auto Chairman Rahul Bajaj has said that although India''s GDP can hit a steady-state of around 8.5 per cent for several years, employment "will not rise at anywhere close to that rate of growth". Terming India's GDP number as "overstated", Morgan Stanley's Chief Global Strategist Ruchir Sharma has called for more private investment for the economy to get back on track. RBI Monday said it has appointed Sudarshan Sen as an Executive Director in place of N S Vishwanathan, who has been elevated as Deputy Governor at the central bank.  A latest breakthrough treatment for the deadly Hepatitis C virus could soon be available in India as 11 Indian firms have been given licenses by its American manufacturer following an approval from US authorities. The Kandla Port has achieved the 6% growth in traffic during the first quarter of financial year 2016-17, as compared to the corresponding quarter of last year. Corporates:  The Cabinet Committee on Economic Affairs has approved increase in foreign investment from the current approved level of 62% to 74% of the total paid up share capital of the Axis Bank on a fully fungible basis. Punjab National Bank’s subsidiary PNB Housing Finance has approached Sebi for an initial public offer to raise Rs 2,500 crore. Adani Ports and SEZ Ltd (APSEZ) Tuesday said it has raised Rs 252 crore through issuance of NCDs on a private placement basis. L&T Tuesday said it has bagged export orders worth USD 71.3 million (nearly Rs 480 crore) from Mitsubishi Hitachi Power Systems Ltd through its two joint venture (JV) firms. The Union Cabinet has approved redevelopment of seven General Pool Residential Accommodation (GPRA) colonies i.e. Sarojini Nagar, Netaji Nagar, Nauroji Nagar through National Buildings Construction Corporation Limited (NBCC) Petronet LNG Ltd has plans to set up a Rs 5,000 crore LNG import terminal at Kutubdia islands in Bangladesh as it looks to build terminals to feed demand in neighbouring countries. Hero MotoCorp has inked a wage settlement pact with its permanent workers at Gurgaon plant, entailing an hike of Rs 12,500 spread over three years. Bharat Financial Inclusion Ltd, formerly known as SKS Microfinance, may raise Rs 10,000 crore during the current fiscal to meet the lending requirements, a top executive of the micro-lender said Wednesday Maruti Suzuki India today said its mid-sized sedan, Ciaz, has crossed the one lakh cumulative sales mark in the domestic market in June, nearly two years after its launch. Indian Oil Corporation (IOC) will invest Rs 40,000 crore to expand its refining capacity to over 100 million tonnes by 2022 After a four-year hiatus, Shipping Corporation of India (SCI) will resume sailing to Iran to ferry ''transport crude oil'' from the Persian Gulf nation for state refiners. Dhanlaxmi Bank today said it will raise Rs 200 crore through issuance of equity shares on preferential basis. C K Birla Group firm Orient Electric is eyeing 20-25 per cent growth in top line this fiscal on the back of increasing demand for its LED lightings and fans, a senior company executive said today. Global events: Hillary Clinton has a lead of nine points over her Republican rival Donald Trump with roughly four-in-ten voters saying it is difficult to choose between them because neither would make a good US president, according to a latest survey by a nonpartisan American think tank. IMF Chief has warned in an interview published on Thursday that anti-trade policies like those championed by Republican presidential candidate Donald Trump risked a protectionist movement that could severely damage global growth. Politics: France submits fresh plan for six nuclear plants in Jaitapur Reshuffling of cabinet took place during the week

NPA sales down to a trickle of just 2% of total bad loans

Notwithstanding rising bad loan problems in the system, sale of stressed assets to asset reconstruction companies (ARCs) in 2015-16 was only a trickle of the NPA mount at 2 per cent of the total of nearly Rs 5.8 trillion, which is down a whopping 20 per cent from previous year, says a report.

Notwithstanding rising bad loan problems in the system, sale of stressed assets to asset reconstruction companies (ARCs) in 2015-16 was only a trickle of the NPA mount at 2 per cent of the total of nearly Rs 5.8 trillion, which is down a whopping 20 per cent from previous year, says a report.

“The overall loans sold in FY2016 were lower by 20 per cent y-o-y and around 15 per cent of the overall loans in the banking system,” Kotak Institutional Equities said today in a report that is based on the analysis of 33 public and private banks.

The report did not offer any reasons for the massive dip in the sales, but it can be noted that banks are not happy with the cheap valuation that ARCs are offering while these companies are capital starved to make the higher upfront payments to the banks. The report also did not quantify the total amount of bad loans sold to ARCs.

As per RBI, total NPAS in the system jumped to 7.6 per cent in 2015-16, up from 4.6 per cent in the previous fiscal, which it warned could jump to a whopping 8.5 per cent by this fiscal end. The total stressed assets including NPAs stood at a staggering 13 per cent or over Rs 8 trillion in 2015-16.

State-run banks sold 75 per cent of their overall bad loans, lower than the 90 per cent of loans sold in 2014-15.

Axis Bank sold the largest quantity of loans but at a significant loss. The SBI Group, however, had the largest share of loans sold at 33 per cent of the overall loans compared to over 60 per cent in 2014-15.

Allahabad Bank and Central Bank were the two large public sector banks which sold a high share of their loans to ARCs last year.

Why central vigilance commission shouldn't be part of a NPA resolution forum

It is a time-honored tenet of the auditing world that an auditor should not partake directly or indirectly in designing a system. The reason is not far to seek. If he does, he would be compromising his position tremendously. For, in that case he would be put in an embarrassing and awkward position of having to audit the very system he has had role in designing.

It is for the same reason the code of conduct for auditors proscribes the statutory auditor of a company from doubling in as its internal auditor as well - as statutory auditor he has to comment upon the adequacy and effectiveness of the internal audit system put in place by the management. The role of internal auditor would conflict with his role as the statutory auditor though in actual practice, auditing firms get round this moral hazard and code of conduct by getting a proxy auditing firm appointed as internal auditor.

It is against this backdrop that the central government’s proposal to set up a NPA resolution forum comprising among others the RBI and the Central Vigilance Commission (CVC) has raised eyebrows and hackles. The implicit rationale underpinning CVC’s induction is its overweening presence would deter and nip in the bud quid-pro- quo deals (mutual backscratching deals to put in more bluntly) between the officialdom and the wily borrower. But what must be nipped in the bud is this hare-brained proposal.

First, any adjustment with an incipient and potential defaulter would involve a small or big sacrifice on the part of the bank. By being a party to such a compromise as a forum member, the CVC would find it difficult to proceed against the banker or any official later on because he would turn around and smugly point out that it was consummated with CVC’s blessings. Surely, CVC as indeed any investigative agency

should be spared the blushes.

It must also be remembered that a committee or forum is by definition perceived as antidote to deals on the sly by individuals. That is why it is said larger the committee the better unless of course all of them fall a prey to blandishments which is unlikely. The point is the forum itself can be counted upon to behave with rectitude without the hawkish presence of the CVC.

Second, banking is not CVC’s forte. It lacks domain knowledge and expertise which RBI has in abundant measure. On the contrary, it would smell rat in any compromise or restructuring. It may not be able to tell between defaults engendered by genuine economic reasons experienced by the borrower and wilful ones.

Thirdly and lastly, the move flies in the face of the recently crafted comprehensive bankruptcy code which sets store by the principle of early resolution of NPA problem without allowing it to fester or take roots. The National Company Law Tribunal (tribunal) that would resolve corporate bankruptcy quickly and comprehensively by addressing the concerns of other stakeholders as well like employees and government should not be snapped at its heels much less exposed to the threat of even being unwittingly marginalised or undermined by a parallel forum.

Parenthetically, it may be mentioned that financially advanced economies have found a way out of the niggling problem of NPAs by simply asking the corporates to seek funds from the bonds market which has its own disciplining mechanism - the threat of being awarded the junk bond status with its grim implications for cost of borrowing. The argument is banks should lend only to small and medium enterprises (SMEs) which cannot access the bond market and which give lesser shocks than a big ticket borrower. But that is another story for another time.

Are private equity investors going slow on India?

Between 2013 and 2015 they PEs increased their exposure little by little and in the first quarter of 2015 they ploughed in USD 4704 million. Right now, their total India exposure is down to USD 1054 million in the second quarter of 2016.

Private equity investors have had a love-hate relationship with India. Just in the last three years, they have yo-yoed a lot in their attentions to India. Between 2013 and 2015 they were upbeat on the Indian subcontinent. The period saw the PEs increasing their exposure little by little and in the first quarter of 2015 they peaked ploughing in USD 4704 million. The same quarter witnessed a total of 112 deals being inked. However, in the last nine months the PEs lost interest. Their total India exposure is down to USD 1054 million in the second quarter of 2016 which had only 52 transactions taking place.  The second infographic shows how internet/technology received the maximum investments of USD 1110 million till date beginning 2016. Business services and transportation clocked the least equity inflows with USD 17 million and USD 12 million, respectively, out of a combined USD 2139 million for the period.

NPAs: Need For A Holistic Approach To Resolution

The banks have been given time till March 31, 2017 by RBI to clean up their books while the gross non performing assets have reportedly ballooned to over Rs 5.5 lakh crore by end of March 2016

Banking system faces enormous challenges as the spectre of gargantuan non-performing assets (NPAs) is haunting them even as the regulator is coming out with new schemes to address the NPA menace head-on.

The banks have been given time till March 31, 2017 by RBI to clean up their books while the gross non performing assets have reportedly ballooned to over Rs 5.5 lakh crore by end of March 2016. This Herculean task needs to be addressed in a holistic manner, keeping the Indian ecosystem in mind, so as to minimise future slippages in the accounts. To begin with, it would be pertinent to recognise that all borrowers are not ‘chors’ and that all lenders cannot be accused of not having done the due diligence and then try to find a resolution before the problem starts eating into the very growth of economy.

Aggravating Factors
The list of factors that caused a jump of more than 475 per cent in NPAs in a matter of 5 years are many. However, factors like commodity cycle downturn, delays in approval from government be it environmental clearance, land acquisition process, obtaining right of way, forest clearance and lack of dispute redressal mechanism in a business-like manner, besides, policychanges like cancellation of telecom licences, withdrawal of coal and iron ore mines, dumping by some countries which made local products unviable, were other contributory factors which were further compounded by the indecisiveness of the decision makers who simply did not take any timely decisions fearing political backlash.

Just to elaborate this point further, let me draw on the steel sector. According to RBI’s Financial Stability Report, June 2015, five out of the top 10 private steel producing companies are under severe stress on account of delayed implementation of their projects due to land acquisition and environmental clearances among other factors. And then the operational units in the steel sector lost their cost competitiveness. As is well-known, some of the critical factors affecting the competitiveness of this industry, particularly in economic downturn, include government’s support (tax incentives), tariff protection, raw material security at competitive prices and availability of infrastructure and logistics. Who would have seen this coming when the projects were set up.

Five Sectors-Demand Upside Holds The Key
It is interesting to note here that five sectors-iron and steel, infrastructure, EPC, mining and textile account for bulk of the reported NPAs which had their share of external factors responsible for accumulation of NPAs in the last 4-5 years. While wilful defaulters need to be dealt with strictly, it is also a fact that all these sectors play key role in the growth of the economy-both at the domestic level and in international trade. A robust revival of demand would enable the companies in these sectors to generate enough cash flows to not only service the debt but return to growth path in a short time.

RBI’s S4A Scheme-May Not Meet With Enough Success
During the last few years, the corporates have piled on an unmanageable mountain of debt without commensurate increase in the earning capacity. In this backdrop, the caveats attached relating to limiting the lenders from changing any of the terms of repayment and interest rate in respect of the sustainable debt portion as also the high level of equity dilution that could be expected with the implementation of the scheme, may lead to limited success and may not meet with the desired results.

Financial Health-palliative Care
As RBI Governor rightly put it, ‘band aid’ approach would not work over a long term. What is needed is a major surgery. While it is a good sign that banks are finally willing to acknowledge the problem, it does not mean that the issue is resolved. The real task begins only now. It is not DRT or CDR or SDR or S4A or Bankruptcy laws alone which can cure this malady. What we need is a macro view taken on the entire economy and then arrive at a resolution strategy which could unlock fair value from the distressed assets for the benefit of all stakeholders. 

The success of the above will to a great extent depend on pro-active measures taken in a co-ordinated manner by Govt. and the Regulator to quickly respond to the challenges being faced by the industry and ensure long term stability in policies which are critical to their well-being. To address the existing NPA problem and protect the economic value of their loan, it is imperative that banks go for a holistic resolution. It is the right time that pain is acknowledged, loan book is corrected, and assets are rightly priced and nurtured further by infusing new money for revival and operations by inviting a new promoter or special situation fund who can bring in their portion of equity or risk capital.

We all understand that without removing the extra flab of debt, the brides may not find any suitors. Further, the investors willing to take over stressed assets are well informed and fully aware of the inherent risks and challenges associated with reviving a distressed company without the support of the old promoters. The new promoter/investor will not be able to bring in the entire equity since Indian businesses cannot sustain superlative returns as they are not very competitive. Thus, it essentially means that the project/company would need to be supported mostly by the existing lenders who have access to cheaper funds in the form of low cost deposits and can manage risk of recovery in the hands of new management/special situation fund who have proven track record of success with higher credibility. When this happens as also with the bankruptcy laws coming in place, the business of investment in distressed assets will become more mature and there will be good interest among serious investors and business assets will be put back to use.

Unlike in other parts of the world, where business successes and failures are taken with equanimity and promoters do not mind shutting the business and moving on, Indians hate ‘failure’ and see failure as a stigma and leave no corner to project success. This die hard belief in making the venture successful and running might turn out to be a blessing in disguise in turning around the stressed assets and resolving the NPAs.

Bankers to conduct marathon meetings to deal with stressed cases

Bankers also intend to evaluate the feasibility of a new financial structuring scheme introduced by the Reserve Bank of India in June

In March, lenders had held similar meetings over two days, where almost all large stressed cases were taken up and tough measures to counter stress were discussed

Lenders, led by State Bank of India (SBI) and ICICI Bank, will conduct extensive joint lender forum (JLF) meetings with the managements of at least 10 stressed firms this month, two people in the know said. Apart from taking stock of progress of these accounts, bankers also intend to evaluate the feasibility of a new financial structuring scheme introduced by the Reserve Bank of India in June.

According to one of the two persons quoted above, an official at a large state-owned lender, this is a quarterly process where banks talk to large stressed companies to monitor the progress of previously approved resolution plans and to decide on new recovery strategies. The banker spoke on conditions of anonymity as he is not allowed to be quoted in the press.

In March, lenders had held similar meetings over two days, where almost all large stressed cases were taken up and tough measures to counter stress were discussed. The companies that banks had met included Visa Steel Ltd, Uttam Galva Steels Ltd, Adhunik Metaliks Ltd, Aban Offshore Ltd, Bhushan Power & Steel Ltd and Bhushan Steel Ltd.

In many cases, banks had asked managements to implement these measures and show results by June end.

“We have already mandated necessary evaluation tests in almost all large stressed cases. In the meetings, we are only focussing on cases where the evaluation tests have established viability. In the other cases, we may look at some other stricter measures,” said the second person quoted above, also speaking on condition of anonymity.

An evaluation test is needed to establish viability if banks choose to go with the Reserve Bank of India’s (RBI’s) newly introduced scheme, Scheme for Sustainable Structuring of Stressed Assets (S4A). Under S4A, which was introduced last month, banks can convert up to half the loans held by corporate borrowers into equity or equity-like securities.